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OK  THE 

University  of  California. 


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BUSINESS  ADIVUNISTRATION 
TEXT  BOOKS 


Business  Economies. 

Business  Organization  and  Management. 

Advertising  and  Salesmanship. 

Trade  and  Commerce. 

Transportation. 

Money,  Banking  and  Insurance. 

Investments  and  Speculation. 

Accounting. 

I  Auditing  and  Cost  Accounting. 

Business  Law  and  Legal  Forms. 


BUSINESS 
ADMINISTRATION 

{THEORY,  PRACTICE  AND  'APPLICATION. 


Editor-In-Chief 

Walter  D.  Moody 

General   Manager,   the   Chicago   Association    of    Commerce, 
Author,  "Men  Who  Sell  Things." 

Managing  Editor 

Samuel  MacClintock,  Ph.  D. 

Editorial  and  Educational  Director, 
La  Salle  Extension  University 


This  work  is  especially  designed  to  meet  the  practical  everyday  needs  of 
the  active  business  man,  and  contains  the  fundamental  and  basic 
principles  upon  which  a  successfid  business  is  founded,  con- 
ducted and  maintained.    To  those  looking  forward  to 
a  business  career,  this  work  forms  the  basis 
for  a  practical  and  systematic  course  in 
"Business  Administration" 


published  by 
LA  SALLE  EXTENSION  UNIVERSITY 

CHICAGO 
OF  THE 

UNIVERSITY 


m^W 


Copyright.  1910, 
L.ASALLB    EXTENSION    UNIVERSITY. 


ACCOUNTING 

^  This  treatise  has  been  especially  prepared  by  Henry 
Parker  Willis,  Associate  Editor,  Journal  of  Accoun- 
tancy, Editorial  Staff,  New  York  Journal  of  Commerce, 
and  Professor  of  Finance,  George  Washington  Uni- 
versity. It  is  supplemented  by  the  writings  of  certified 
public  accountants,  auditors  and  expert  bookkeepers.  It 
is  a  popular  and  authoritative  exposition  of  the  theory 
and  practice  of  accounting,  according  to  the  best  pres- 
ent-day standards,  and  contains  many  concrete  ex- 
amples, practical  ideas  and  helpful  suggestions.  This 
volume  and  its  companion  work  on  Auditing  and  Cost 
Accounting  contain  the  information  leading  to  the  Cer- 
tified Public  Accountant  examination.  The  work  is 
arranged  to  serve  as  a  guide  and  reference,  and  in- 
cludes a  complete  table  of  contents,  a  comprehensive 
index  and  test  questions. 

Walter  D.  Moody, 

Editor-in-Chief. 


O  i\  Q  •<*  Q  ^ 


INTRODUCTION  TO  BUSINESS  ADMINISTRATION. 

BY  WALTER  D.  MOODY. 

General  Manager,  The  Chicago  Association  of  Commerce. 
Author  of  "Men  Who  Sell  Things." 

*'The  recipe  for  perpetual  ignorance  is:    Be  satisiied  with  your  own 
opinion  and  content  with  your,  knowledge." 

This  is  an  era  of  the  greatest  commercial  ac-» 

Business  a  contest      tivity  the  world  has  ever  known.    The  deveU 

of  wits  -     opment  of  business  is  one  of  the  marvels  of 

the  new  century.     ^K  few  years  ago  science, 

as  a  factor  in  commerce,  was  little  known  and  less  appreciated.     The 

amazing  advantages  to  business  of  Intellectual  attainments  were  utterly 

without  recognition.    Today,  however,  business  has  become  a  contest  in 

which  the  quickest  perception  wins,  thus  transforming  the  counting  room 

into  a  battle  ground  upon  which  brain  matches  brain  for  supremacy  and 

success. 

Jhh,  that  enchanting  word,  S-U-C-C-E-S-S.    It 
Success— educated       does  not  require  a  magic  key  to  unlock  the 
enthusiasm      <     door  to  business  efficiency.    There  is  nothing 
mystic,  nothing  mysterious     in  the     applied 
method  of  the  really  resourceful  men  in  this  day  of  great  successes,  of 
marvelous  achievements  in  business  enterprise.     The  sum  total  is  con- 
tained in  two  words,  words  that  electrify,  nevertheless.  EDUCATED 
ENTHUSIASM. 

The  most  formidable  barrier  to  progress  has 
Changing  conditions     always  been  the  senseless  opposition  of  those 
make  to  whom  it  would  be  of  the  greatest  benefit. 

opportunities  Changing  conditions  are  the  order  of  the  day, 

for  enlightenment  has  worked  wonders.  In 
olden  times,  a  man  of  affairs  was  obliged  to  guard  his  property  and  his 
loved  ones  by  building  a  moat  around  his  house  and  posting  sentinels  in 
and  around  his  estate.  The  time  is  not  long  past  when,  because  of  preju- 
dice, perversity  or  ignorance,  many  men  believed  that  opportunity  knocked 
only  once  at  any  man's  door.  Today,  thanks  to  deeper  insight,  most  men 
beheve  that  life  itself  is  opportunity;  that  the  very  air  we  breathe  is 
opportunity ;  that  each  new  day  presents  broader  opportunities  for  accom- 


INTRODUCTION! 

pushing  more  Because  of  better  directed  energy,"  Tfiis  is~not  alone  the 

accepted  dogma  of  the  man  who  is  making  his  way  in  the  world.  It  is 
the  creed,  doctrine,  tenet  or  religion,  whichever  you  may  care  to  term  it, 
of  the  great  captains  of  industry  everywhere. 

The  more  successful  the  man,  the  more  does 
New  ideas  county  he  think,  study,  plan,  as  a  part  of  his  daily 
occupation  in  the  development  of  the  affairs  in 
which  he  is  interested.  Newer  and  better  ways  to  get  things  done  is  the 
business  standard  employed  today  by  successful  men  in  all  lines.  Only 
yesterday  if  a  man  of  genius  advanced  a  new  idea,  he  found  himself 
ridiculed  and  his  innovation  opposed  on  all  sides  because  it  was  a  new 
idea.  Today,  it  is  different.  The  man  of  ideas  counts  in  the  trend  of 
affairs  as  he  has  never  counted  before. 

Everything  has  a  subjective  reason.    Progress 
Must  keep  step  with     is  acting  as  a  mighty  dynamic  force  in  chang- 
changing  times  ing  men's  viewpoint  of  life  and  things.    Sup- 

pose the  stroke  oar  on  a  varsity  crew,  while  in 
a  race  against  an  opposing  crew  from  a  competitive  institution,  should 
suddenly  stop  rowing  in  harmony  with  his  associates  and  begin  to  row 
backwards — ^that  crew  would  not  get  very  far  without  trouble.  Suppose 
a  lawn  mower  should  be  reversed  and  forced  to  run  backwards — there 
would  not  be  much  progress  made  in  cutting  grass  on  that  lawn.  Varsity 
crews  and  lawn  mowers  must  move  forward.  Business  men  must  ad- 
vance with  the  times. 

A  great  merchant  in  Chicago  tells  a  good  story  of  his  youth.  He  was 
a  member  of  a  state  regiment  of  militia.  On  a  certain  occasion,  his  com- 
pany was  sent  out  on  dress  parade.  An  old  maiden  aunt,  with  consider- 
able colonial  blood  in  her  veins,  took  much  pride  in  her  nephew  and  his 
company.  While  reviewing  the  parade,  she  was  suddenly  heard  to  ex- 
claim :  "Why,  every  single  man  in  that  company  is  out  of  step  excepting 
my  nephew."  Most  men  who  fail  to  get  on  in  the  world  do  not  realize 
that  success  lies  in  keeping  step — in  making  progress  with  changing  condi- 
tions. They  generally  make  the  mistake  of  thinking  that  the  world  and 
everything  in  it  is  out  of  harmony  with  themselves. 

A  business  man  of  successful  experience  rea- 
New  ideas  worth        lizes  that  ideas — newer  and  better  principles  of 
searching   for  conducting  business — are  of  the  greatest  value, 

and  he  also  knows  that  it  pays  him  to  search 
for  them.  The  same  old  way  of  doing  things  cannot  longer  be  success- 
fully employed  month  after  month  and  year  after  year  as  under  the  old 
regime.  The  business  man  must  be  modern,  up-to-date.  The  physician 
or  lawyer  finds  that  to  compete  successfully  he  is  compelled  to  search 


INTRODUCTION 

without  ceasing  in  order  that  he  may  comprehend  the  advancement  in 
treatments  or  procedures.    "To  the  man  who  fails  belong  the  excuses.'* 

President  James,  of  the  University  of  Illinois, 

'Demand  for  trained      was  asked  if  there  was  any  demand  .from  busi- 

men  ness  houses  for  college-bred  men.    His  reply 

was :  "The  demand  has  been  far  in  excess  of 
tHe  supply  since  courses  in  business  administration  were  established  in 
our  institution  seven  years  ago.  Each  year  has  brought  many  more 
requests  than  we  have  men  to  recommend."  Ten  years  ago  President 
James  would  have  been  ridiculed  for  advancing  this  new  idea  for  the 
establishment  of  a  school  of  commerce  in  connection  with  a  university. 
Today,  commercial  schools  are  a  part  of  the  regularly  established  courses 
of  nearly  all  of  the  great  universities  of  our  country.  Men  trained  in  the 
theory,  practice  and  administration  of  business  will  always  occupy  the 
(best  positions  and  will  always  command  the  greatest  salaries. 

All  men  fail  at  times  in  the  accomplishment  of 

Value  of  new  ideas      satisfactory  results  in  the  various  enterprises 

in  in  which  they  are  engaged,  without  being  able 

business  emergencies    to  give  an  explanation.     The  principles  that 

have  been  applied  successfully  for  many 
years  seem  apparently  to  Have  counted  for  nothing.  It  is  frequently  evi- 
dent that  in  such  cases  a  very  insignificant  thing,  a  mere  oversight  per- 
chance, has  been  the  direct  cause  of  the  failure.  To  be  able  to  put  the 
finger  on  the  precise  cause  of  the  lack  of  success  in  one's  method  would 
locate  the  cause  of  the  disaster.  Then  it  is  that  a  real  appreciation  of 
new  ideas  is  fully  realized. 

Failure  is  more  often  chargeable  to  a  refusal 

Men  paid  for  what      to  learn  by  mistakes  how  to  avoid  them  than  it 

they  know — ^not         is  in  making  them.     Experience  is   a  good 

for  what   they   do      teacher,  but  who  can  deny  the  value  to  be 

gained  in  learning  from  the  experience  of 
OtHers,  for  we  cannot  all  have  the  same  experience  or  the  same  view  of 
similar  experiences.  There  are  many  pathways  to  success,  but  the  road 
of  individual  experience  is  narrow  and  rugged.  It  is  a  commonly  ac- 
cepted fact  that  for  every  ten  dollars  ^  high-salaried  man  draws,  he  re- 
ceives nine  dollars  for  what  he  knows  and  one  dollar  for  what  he  does. 
On  the  same  basis  the  successful  business  man,  employing  a  large  force 
of  other  men,  realizes  that  his  own  greatest  worth,  as  applied  to  his 
affairs,  lies  not  so  much  in  what  he  can  do  himself  as  how  much  he  can 
encourage  his  employes  to  do.  In  either  case,  his  own  personal  knowl- 
edge is  the  power  behind  the  throne. 


INTRODUCTION 

The  man  who  would  secure  the  largest  net  re- 
Knowledge  in  excess    turn  from  his  individual  effort  in  the  field  of 
of  present  needs        endeavor,  and  he  who  would  realize  the  great- 
necessary  est  possible  advantage  from  the  efforts     of 
those  under  his  command  must,  of  necessity, 
possess  knowledge — indispensable  perception  far  in  excess  of  the  needs  of 
the  moment.     Discernment,  like  a  bank  account,  soon  runs  out  if  it  is 
overdrawn  or  if  it  is  not  continually  replenished.    In  business  the  "check- 
ing system"  of  knowledge  is  the  sort  of  account  that  pays  best — not 
the  "savings  account  system."     Knowledge  that  is  simply  corked  up  and 
allowed  to  accumulate  cobwebs  and  rust  can  avail  nothing.    The  sharpest 
vinegar  is  procured  by  constantly  replenishing  the  old  stock  with  new. 

Reliable  statistics  prove  that  only  about  ten 

90%  failures  per  cent  of  all  people  who  engage  in  business 

vs.  are   successful   and  make  money;   the   other 

10%    moneymakers      ninety  per  cent  become     insolvent     and  fail. 

That  is,  they  do  not  actually  encounter  the 

sheriff,  or  go  into  the  hands  of  a  receiver,  but  they  fail  nevertheless  to 

succeed  in  the  sense  of  making  money,  and  what  other  possible  reason 

can  anyone  have  for  engaging  in  business  if  not  to  accumulate  money? 

JWhy  do  so  many  fail?    Ask  any  credit  man 
Failures  due  to  lack      and  he  will  tell  you  that  it  is  not  because  of 
of  intellectual  the  lack  of  capital,  or  other  material  resources, 

capacity  but  'it  is  due  primarily  to  a  lack  of  intellectual 

capacity,  the  sort  of  brains  that  dig  and  work 
and  sweat  until  they  find  a  way  to  accomplish  things ;  brains  that  go  to 
the  bottom  of  things;  brains  that  are  always  looking  for  better  results; 
brains  that  never  abandon  a  problem  until  they  have  found  a  way  to 
solve  it.  A  friend  once  told  me  that  he  inquired  of  the  manager  of  a 
house  employing  some  three  hundred  traveling  men  how  many  salesmen 
they  had.  The  manager  replied,  "Three."  My  friend  asked,  "How's 
that?  I  am  told  your  force  of  traveling  men  numbers  nearly  three  hun- 
dred." "Ah,  that  is  quite  different,"  replied  the  manager ;  "we  have  two 
hundred  and  ninety-seven  traveling  men,  but  only  three  salesmen." 
Quite  likely  that  manager's  estimate  was  intended  to  be  taken  figuratively 
rather  than  literally,but  It  serves  to  illustrate  the  fact  that  in  this  great 
United  States  there  are  millions  of  men,  young,  middle-aged  and  old,  who 
are  content  to  plod  along  in  a  mediocre  sort  of  way,  heedless  or  unmindful 
of  the  fact  that  opportunity,  knowledge,  possibilities,  are  calling,  calling, 
calling  to  them  to  come  up  higher.  There  are  hundreds  of  thousands  of 
other  men  engaged  in  business  who  sit  idly  by  while  their  trade,  like  the 


INTRODUCTION 

sands  in  the  hour  glass,  slowly  ebbs  away,  and  eventually  is  absorbed  by 
their  more  progressive  business  neighbors. 

There  is  still  another  vast  army  of  business 
Moneymaking  and  men — salesmen,  clerks  and  wage-earners  of  all 
business  literature  classes — who  are  beginning  to  catch  a  glimpse 
of  the  dawning  of  a  new  business  era,  the 
greatest  the  world  has  ever  known,  an  era  impregnated  with  possibilities 
and  opportunities  for  those  who  are  ready  with  wicks  trimmed  and  oil 
in  their  lamps.  To  the  earnest  latter  class  which  is  really  desirous  of 
profiting  by  the  experience  of  others,  there  is  no  need  of  elaborating  the 
possibilities  embodied  in  this  course  of  reading  in  Business  Administra- 
tion. This  set  of  books,  containing  valuable  business  data  on  many  sub- 
jects, thousands  of  pages  telling  the  story  of  success  illustrated  by  trained 
men  whose  names  are  respected  everywhere,  is  intended  to  reach  all 
classes.  There  is  absolutely  nothing  in  print  that  can  even  approach  or 
can  begin  to  compare  with  it  In  value  as  a  reference  library  for  business 
men  or  excel  it  as  a  complete  course  of  Instruction  for  any  man  desirous 
of  making  the  best  of  his  possibilities  and  opportunities  in  the  kaleido- 
scopic age  through  which  the  business  world  is  now  moving. 

The  more  practical  the  Ideas,  the  better  the 
Practical  ideas  best  basis  for  good  work.  Not  long  since,  busi- 
ness men  generally  pooh-poohed  the  idea  of 
employing  In  the  conduct  of  their  business  anything  new,  which  was  taken 
from  the  writings  and  experience  of  others,  such  as  Is  contained  In  this 
remarkable  series,  contributed  to  by  some  of  the  brightest  minds  in  the 
business  world  today.  There  is,  however.  In  these  days  unmistakably  a 
hungering  and  thirsting  for  just  this  new  sort  of  literature.  It  fills  a  long- 
felt  need — fills  it  exactly,  completely,  satisfactorily.  Being  the  author  of  a 
work  on  salesmanship  which  has  had  a  countrywide  circulation,  I  hare 
been  literally  besieged  by  business  men  everywhere  asking  me  to  recom- 
mend books  treating  of  successful  business  methods,  and  have  been  cha- 
grined to  find  how  limited  was  the  supply.  The  man  who  formerly  was 
prejudiced  against  such  sources  of  information  must  now  step  aside 
and  make  way  for  progress  or  unite  with  the  popular  demand  for  more 
education  and  better  methods. 

Show  me  the  man  who  says  he  has  no  pa- 

Cannot  afford  tience  for  such  things,  and  I  will  show  you  a 

vs.  man,  like  the  stroke  oar  and  the  lawn  mower, 

can  afford  who  does  not  believe  in  moving  forward  in 

progress.    Show  me  the  man  who  says  he  has 

no  time  to  read  of  new  methods  and  principles,  and  I  will  show  you  the 

one  who  utterly  fails  to  perceive  that  familiarity  with  business  literature 

of  this  kind  means  pecuniary  advancement.    Show  me  the  man  who  says 


iLNTRODirCTION 

he  cannot  afforS  to  invest  in  such  a  set  of  books,  and  I  will  show  you 
one  who  apparently  CAN  afford  to  waste  his  energy  in  misdirected 
effort — that  energy  and  effort  which  are  to  every  wage-earner  and 
tradesman  both  his  stock  in  trade  and  his  invested  capital. 

Someone  has  said,  "There  are  three  kinds  of 
Failures  people  in  the  world — ^the  Can'ts,  the  Won'ts 

unnecessary  and  the  Wills.     The  first  fail  at  everything; 

the  second  oppose  everything;  the  third  suc- 
ceed at  everything."  I  would  add  a  fourth  kind — the  largest  class  of  all 
— the  Don't  Trys,  the  "Oh-what's-the-use/'  "It-doesn't-interest-me"  sort 
of  people.  Their  name  is  legion ;  their  fault  is  lack  of  confidence.  Knowl- 
edge is  the  greatest  inspiration  of  confidence  to  be  found  on  earth.  You 
may  not  personally  be  held  in  the  hope-paralyzing  bondage  that  produces 
the  "Oh-what's-the-use,"  or  *T'm-not-interested"  germ,  but  if  you  are  not, 
you  are  exceptional.  Most  people  are,  and  that  is  the  reason  that  such 
persons  are  just  about  what  luck,  good  fortune  or  chance  make  them, 
succeeding  if  fortune  favors  them,  failing  if  they  are  left  to  depend  upoa 
their  own  resources.    Result :     Nine  fail  where  one  succeeds. 

It  is  very  fortunate,  indeed,  for  most  men  that  so  much  of  their  happi- 
ness depends  upon  success.  There  is  nothing  on  earth  quite  so  terrible 
to  think  of  as  failure,  especially  that  due  to  lack  of  effort,  unless  possibly  it 
be  the  failure  of  a  man  who  lacks  the  courage  or  initiative  to  try  to  make 
the  most  of  himself,  and  thus  lets  his  best  opportunities  escape  him.  And 
this  last  is  really  the  most  pitiful  thing  that  can  befall  a  man.  It  is  well 
enough  to  plan  opportunities,  but  if  we  had  the  wisdom  to  take  advantage 
of  such  opportunities  as  naturally  come  to  us,  results  would  more  often  be 
found  in  the  balance  on  the  right  side  of  the  ledger.  And  so  I  am  of  the 
opinion  that  a  clear  explanation  of  why  a  very  large  class  of  people  do  not 
succeed  is  found  in  some  of  these  expressions — "I  don't  care,"  "I  can't," 
"It  doesn't  interest  me/'  or  "Oh,  what's  the  use." 

One  of  the  great  objects  set  forth    in  this 
Basis   of  all  busi-      Business  Administration  series  is  to  supply  the 
ness  success  positive  energy  which  begets  courage,  confi- 

dence, initiative  and  success.  We  want  to 
make  you  feel  the  necessity  of  doing  some  reading,  a  little  plain  think- 
ing, and  to  make  as  clear  as  possible  the  important  things  that  are  in- 
volved in  the  serious  but  very  fine  game  of  business. 

With  business  becoming  with  each  succeeding  day  more  and  more  of 
a  science,  it  is  high  time  to  understand  what  is  essential  to  it.  Speaking 
of  the  subject  of  "Organized  Business,"  a  great  authority  recently  said, 
*'It  is  time  even  for  business  men  to  understand  business."  Again,  the 
purpose  of  this  course  in  Business  Administration  is,  if  possible,  to  meas- 
ure the  power  and  principles  of  business,  to  trace  their  ramifications,  de- 


INTRODUCTION 

fine  their  elements,  get  hold  of  their  vital  fundamentals,  and  so  compre- 
hend them,  both  in  technical  detail  and  as  a  mighty  unit.  And  I  am  confi- 
dent we  have  done  all  this.  I  find  that  at  the  foundation,  the  machinery 
of  business  is  simple,  but  whether  it  is  plain  or  complicated,  all  who  would 
succeed  must  make  every  effort  to  comprehend  it  thoroughly.  All  I 
care  to  emphasize  at  present  is  the  great  truth  that  knowledge,  estab- 
lished and  classified,  is  the  basis  of  all  business  success.  This  is  clearly 
established  in  this  course  of  reading,  and  I  am  trying  to  incite  your 
imagination  in  writing  of  its  merits  just  as  I  would  endeavor  to  enable 
you  to  realize  it  if  I  could  talk  to  you  personally  right  across  my  desi?. 
The  observant  man  can  see  clearly  the  things  I  am  talking  about,  but  to 
most  men  the  mind's  eye  perceives  not  by  observation,  but  only  when  the 
imagination  is  stimulated.  So  I  would  stir  all  men  to  look  earnestly  into 
these  things,  with  a  view  to  their  personal  betterment. 

Business  is  far  more  than  business  as  it  is  com- 

'Business  axioms        monly  understood.     It  is  a  science,  and  it  is 

simple   to  the  eager,  practical  minds  of  business  men  that 

understand  we  shall  endeavor  to  convince  first  of  that 

fact,  and  our  reasons  for  addressing  those 
principally  concerned  are  especially  good.  Why?  I  have  found  that  in 
writing  about  business  whenever  I  was  able  to  make  the  principles  so 
plain  that  business  men  understood  them,  everybody  else  did,  so  it  is  to 
be  expected  that  if  business  axioms  can  be  made  simple  enough  for  busi- 
ness men  to  understand  them,  everyone  will  apprehend  them.  Every- 
body^.   5\nd  it  is  everybody  that  we  are  attempting  to  reach. 

For  nearly  thirty  centuries  men  have  recog- 

Knowledge  is  nized  the  concrete  wisdom  of  Solomon's  prov- 

power  erb:    "A  wise  man  is  strong;  yea,  a  man  of 

knowledge  increaseth  in  strength.'^  Yet  we 
liave  been  slow  In  making  its  application  universal  to  the  race.  But  we 
are  beginning  to  understand  that  the  power  inherent  in  knowledge  applies 
as  well  to  commercial  and  industrial  as  to  scholastic,  political  and  social 
life,  as  well  to  the  counting  room  as  to  the  pulpit,  as  well  to  the  shop  as 
to  the  university,  as  well  to  the  farm  as  to  the  bar.  Knowledge  is  power 
and  is  the  only  source  of  real  intellectual  sovereignty  that  the  Creator  has 
ever  entrusted  to  men. 

In  conclusion,  I  would  say  that  these  words  are  addressed  to  the 
business  men  of  Kmerica,  and  this  designation  includes  the  banker  and 
his  clerks,  the  farmer  and  his  sons,  the  lawyer  and  the  law  student,  the 
financier  and  the  man  who  sells  bonds  and  stocks,  the  merchant  and  his 
clerk,  the  accountant  and  the  bookkeeper,  the  manager  and  his  assist- 
ants— the  ambitious  young  men  of  the  Twentieth  Century  type,  contem- 
plating the  pursuit  of  any  business,  trade  or  occupation. 


CONTENTS 

ACCOUNTING. 

PART  I. 

Page. 
The  Principles  of  Accounting. 

By  Henry  Parker  Willis 1 

Introduction —  1 

I.  Fundamental  Ideas —  2 

Nature  of  Commerce — What  is  Accounting — Relation  to  Economics — 
What  is  Bookkeeping — The  Accounting  Profession — Development  of 
Accountancy — Scope  of  Accountancy  Examinations. 

II.  Construction  of  the  Account —  9 

Object  of  the  Account — Classification  of  Facts — Losses  and  Gains — 
Debtor  and  Creditor — Nature  of  the  Account — The  Accounting  System 
— Accounts  Reviewed — The  Accounts  of  John  Smith. 

III.  Keeping  the  Books —  24 

Practical  Problems — Traditional  Books — The  Ledger — The  Journal — 
Classification  of  Books — Classes  of  Ledgers — Other  Books — Relation 
Between  Books — Balancing  and  Closing — Technique  of  Closing — Bal- 
ance Sheet. 

IV.  Capital—  43 

The  Capital  Account — How  Capital  is  Contributed — Corporation  Capi- 
tal Accounts — Stock  Retained-^Payment  for  Stock — Payment  for 
Bonds. 

V.  Cash  Account —  54 

Theory  of  Cash — Modern  Means  of  Payment — The  Bank  and  the 
Check — Use  of  Commercial  Paper — Process  of  Discount — Bills  Dis- 
honored— Bills  Payable — Relation  Between  Cash  and  Quasi-Cash  Ac- 
counts. 

VI.  Goods  Accounts —  68 

Nature  of  Goods — Goods  on  Invoice — Goods  Returned — Consignments 
— Trading  Accounts — Closing  Inventory. 

VII.  Plant  and  Property  Accounts —  83 

Relation  to  Preceding  Discussion — Plant  and  Property  Accounts  De- 
scribed— Depreciation — "Wilting  Down"  the  Assets — "Writing  Down" 
not  always  Satisfactory — Depreciation  Reserve — Choice  of  Methods — 
Causes  of  Deterioration — Estimating  Depreciation — Example  of  In- 
surance Policy — Appreciation. 

VIII.  Manufacturing  Accounts —  103 
Special  Problem  of  Manufacturing — Organization  of  Accounts — Pecul- 
iarity of  Manufacturing — Technical  Profit  or  Loss — Selling  the  Goods — 
Contents    of    General    Ledger — Aids   to   the   Accounting — Analysis    of 
Business. 

IX.  Cost  Accounting —  _  122 

Reason  for  Cost  Accounting — Object  of  Cost  Accounting — Simple  Cost 
Accounting — Individual  Cost  Sheets — Cost  Accounts  in  the  General 
Books — Cost  Books — Cost  Ledger — Analysis  of  Costs — Bases  of  Cost 
Accounting — Selecting  a  Cost   System — Accounting  Controversies. 


ii  CONTENTS 

X.    Profit  and  Loss  Accounts —  144 

Relation  of  Profit  and  Loss  to  Business — General  Profit  and  Loss  Ac- 
counts— Sections  of  Profit  and  Loss — Uses  of  Profit  and  Loss  Account 
— Income  and  Expenditure — Income  Sheet  of  a  Railroad — Business 
Results — Profit  and  Loss  Analysis — Declaration  of  Dividends. 

XL  The  Balance  Sheet —  161 

Object  of  the  Balance  Sheet — What  are  Assets  and  Liabilities — Pre- 
paring the  Balance  Sheet — Form  of  Balance  Sheet — Grouping  the  Items 
— Interpretation  of  Balance  Sheet — Capital  and  Revenue  Items — State- 
ment of  Affairs. 

XIL  Auditing  and  Reporting —  184 

Object  of  ail  Audit — Checking  the  Accounts — Protection  Against  Fraud 
— Responsibilities  of  Auditor — Report  on  Condition  of  Business — Ex- 
amples of  an  Audit — Analysis  of  Accounts — The  Auditor's  Report. 

PART  II. 

Introduction 207 

Works  for  the  Study  of  Accounting 210 

Accountancy   Examinations    211 

Examinations  on  the  Theory  of  Accounts  225 

Accounting  Terminology    245 

Some  Recent  Changes  in  Government  Accounting. 

By  Henry  Parker  Willis 315 

Corporation   Tax   Regulations    348 

The  Federal  Corporation  Tax  and  Modern  Accounting  Practice. 

By  A.  M.  Sakolski 367 

Primer  on  Cost  Keeping 387 

Some  Principles  of  Cost  Accounting. 

By  Ernest  Reckitt   415 

People  Ex  Rel.  Manhattan  Railway  Co.  v.  Barker 430 

City  of  Knoxville  v.  Knoxville  Water  Co 437 

Wilcox  et  al.  v.  Consolidated  Gas  Co 440 

The  Balance  Sheet  of  a  Railway  465 

The  Accounts  of  a  Telephone  Company 494 

Quiz  Questions 525 


THE  PRINCIPLES  OF  ACCOUNTINa 

BY  HENRY  PARKER  WILUS,  Ph.  D. 

fBorn  Weymouth,  Mass.,  1874;  B.  A.,  University  of  Chicago,  1894;  Student 
University  of  Berlin.  University  of  Leipsic,  University  of  Vienna,  1896-7; 
Ph.  D.,  University  of  Chicago,  1898;  Assistant  Indianapolis  Monetary  Commis- 
sion and  Joint  Author  of  its  Report,  1898;  Adjunct  Professor  Economics  and 
Politics,  Washington  and  Lee  University,  1898-1901;  Editorial  Writer  New- 
York  Post  and  Nation,  1901-1902;  Wilson  Professor  of  Economics  and  Poli- 
tics in  Washington  and  Lee  University,  1903-6;  Editorial  Writer  and  Wash- 
ington Correspondent.  New  York  Journal  of  Commerce  and  Commercial  Bul- 
letin, 1906 — ;  Professor  of  Finance  George  Washington  University,  1906 — ; 
Associate  Editor,  Journal  of  Accountancy.] 

PART  I. 

INTRODUCTION. 

The  following  pages  have  been  written  for  the  purpose 
of  setting  forth  the  general  principles  upon  which  modem 
accounting  systems  in  the  broad  sense  of  the  term  are  or- 
ganized. Comparatively  little  attention  has  been  paid 
to  bookkeeping  as  such,  therefore,  the  treatment  offered 
in  Sections  II  and  HI  being  intended  simply  to  afford  a 
basis  or  setting  for  the  theory  of  the  account  and  its  rela- 
tion to  the  traditional  or  conventional  books  of  account. 
While  it  has  not  been  attempted  to  go,  in  detail,  into  all 
of  the  books  that  are  customarily  employed,  or  to  give 
forms  representing  more  than  a  very  few  of  them,  it  has 
been  sought  to  present  enough  elementary  descriptive  mat- 
ter to  make  plain  the  theoretical  treatment  in  its  applica- 
tion to  the  bookkeeping  side  of  the  subject.  On  the  other 
hand,  it  has  been  attempted  to  avoid  purely  abstract  dis- 
cussion of  the  philosophy  of  accounts  and  to  emphasize  the 
discussion  of  the  principles  upon  which  actual  accounting 
is  founded.  The  reader  who  has  not  already  made  a  study 
of  bookkeeping  technique  should  read  in  conjunction  with 
this  discussion  some  work  on  practical  bookkeeping.    A 

1 

B— VIII— 1 


2  HENRY  PARKER  WILLIS 

list  of  available  works  on  arccounting  and  bookkeeping  is 
afforded  in  Part  II,  p.  210,  of  the  present  volume. 

I.     FUNDAMENTAL  IDEAS. 

Nature  of  Commerce. 

The  process  by  which  economic  relations  between  men 
are  carried  on  is  ordinarily  known  as  trade  or  commerce. 
Such  commerce  consists  of  the  exchange  of  goods  against 
goods,  services  against  services,  services  against  goods,  or 
any  one  or  all  of  these  against  money.  In  practice,  civ- 
ilized societies  state  all  transactions  in  terms  of  money, 
and  even  where  an  interchange  of  goods  takes  place  upon 
what  amounts  to  a  basis  of  barter,  the  operation  is  usually 
reduced  to  terms  of  money,  and  thus  a  common  denom- 
inator designed  for  the  purpose  of  rendering  transactions 
readily  comparable  is  adopted.  The  fact  that  in  practice 
such  a  common  denominator  is  in  this  way  accepted  and 
that  every  transaction  is  reduced  to  a  money  basis,  renders 
it  possible  to  institute  comparisons  of  commercial  transac- 
tions which  shall  show  what  the  net  outcome  of  a  complex 
process  of  buying  and  selling  is.  At  the  same  time,  the 
complexity  of  such  a  process  of  buying  and  selling  in  dif- 
ferent quantities  and  to  different  individuals  as  well  as  at 
different  rates,  renders  it  imperative  that  an  individual  or 
group  of  individuals  engaged  in  the  process  of  interchang- 
ing goods  or  services  with  others  shall  have  some  system 
whereby  operations  are  regularly  recorded.  If  there  were 
no  such  system,  confusion  would  exist  as  soon  as  the  vol- 
ume of  the  transactions  handled  at  all  exceeded  what  could 
be  readily  carried  in  a  single  memory.  Moreover,  as  soon 
as  transactions  reach  a  somewhat  developed  stage,  it  be- 
comes evident  that  a  mere  straightforward  record  of  what 
has  been  bought  and  what  has  been  sold  does  not  suffice 
to  indicate  the  true  position  of  the  owners  of  the  goods. 
Economic  institutions,   such   as   banking,  transportation, 


THE  PRINCIPLES  OF  ACCOUNTING  3 

and  tlie  like,  involve  readjustments  of  relationships  be- 
tween traders  whieh  necessarily  have  to  be  represented 
in  some  way  more  or  less  corresponding  to  the  complexity 
of  the  subject-matter,  although  aiming  at  the  ultimate  re- 
duction of  these  complexities  to  a  final  simplicity. 

What  Is  Accounting? 

The  body  of  principles  under  which  business  transac- 
tions are  thus  recorded  in  an  orderly  form  and  in  their 
proper  relation  to  one  another,  is  called  accounting.  Ac- 
counting is  a  science  which  aims  at  the  systematic  pres- 
entation of  business  facts  and  whose  rules  are  designed 
to  indicate  or  state  the  principles  upon  which  such  a  record 
of  business  facts  must  be  made.  In  current  discussion, 
there  is  a  good  deal  of  confusion  about  the  use  of  the  term 
accounting.  By  many  the  word  is  made  synonymous  with 
the  word  bookkeeping,  as  if  the  two  were  substantially 
identical.  Some  persons  use  the  term  accounting  as  if  it 
were  merely  a  high-flown  expression  for  the  word  book- 
keeping, while  others  admit  the  existence  of  a  difference 
between  the  two  ideas  but  consider  that  accounting  is 
merely  '* advanced"  or  ''difficult"  bookkeeping.  This  con- 
fusion of  ideas  is  injurious  to  the  proper  development  of 
a  science  of  accounting,  as  well  as  to  the  proper  statement 
of  bookkeeping  methods.  It  should  be  recognized  at  the 
outset  that  the  term  "accounting"  is  properly  used  only 
when  applied  to  the  principles,  system,  or  theory  by  which 
business  facts  are  recorded  with  the  design  of  showing 
certain  classes  of  results,  or  to  the  system  or  theory  in  ac- 
cordance with  which  business  facts  are  so  analyzed  as  to 
exhibit  their  relationships  to  one  another. 

Relation  to  Economics. 

Thus  defined,  accounting  appears  as  an  important 
branch  of  economics.  Economics  may  be  regarded  as  that 
science  which  deals  with  the  relationships  of  men  in  re- 


4  HENRY  PARKER  WILLIS 

gard  to  wealth.  Accounting  is  an  analytical-descriptive 
phase  or  branch  of  economics;  it  is  the  phase  of  economics 
which  sets  down  or  arranges  the  results  of  actual  economic 
transactions  in  such  a  way  as  to  exhibit  the  outcome  of 
those  transactions.  A  correct  application  of  accounting 
will  not  only  set  forth  the  truth  about  a  given  set  of  busi- 
ness transactions,  but  it  will  exhibit  the  effect  of  a  series 
of  business  transactions  in  comparison  with  a  similar  se- 
ries elsewhere  or  at  some  other  time.  It  will  render  pos- 
sible the  reduction  of  net  results  of  business  transactions 
to  a  common  and  comparable  basis  so  that  they  may  be 
contrasted  with  others  or  with  what  is  recognized  as  the 
standard  or  normal  outcome  of  such  a  set  of  transactions. 
Accounting  has  also  its  analytic  side — the  converse  of  its 
constructive — which  affords  the  basis  for  the  study  of  ex- 
isting commercial  institutions  from  the  standpoint  of  in- 
vestment and  speculation,  and  which  furnishes  the  founda- 
tion for  correct  auditing  principles.  This  conception  of 
accounting  places  the  subject  in  a  serious  and  dignified  re- 
lationship to  the  science  of  economics  as  a  whole,  and  lays 
stress  upon  the  necessity  of  a  systematic  development  of 
accounting  ideas  in  harmony  with  the  best  results  of  eco- 
nomic thought. 

What  Is  Bookkeeping? 

But  what  is  bookkeeping'?  The  term  as  ordinarily  em- 
ployed simply  means  the  recording  of  business  transac- 
tions in  any  given  enterprise  or  undertaking  in  accordance 
with  a  previously  determined  system  or  plan.  Bookkeep- 
ing is  thus  recognized  as,  properly  speaking,  an  art.  The 
bookkeeper  stands  in  relation  to  the  accountant  in  precisely 
the  same  position  as  does  the  engineer  in  relation  to  the 
builder  of  the  engine  he  is  operating.  The  engine-builder 
has  devised  a  machine  for  the  economical  performance  of 
certain  work;  it  is  the  function  of  the  engineer  to  operate 
that  machine.     The  accountant  provides  a  system  upon 


THE  PRINCIPLES  OP  ACCOUNTINa  5 

wMcli  tlie  facts  of  business  may  best  be  recorded.  The 
bookkeeper,  in  pursuance  of  that  system,  records  the  facts 
from  day  to  day,  following  out  the  methods  of  analysis 
and  combination  which  the  accountant  has  indicated.  EQs 
work  is  not  necessarily  mechanical,  because  under  certain 
conditions  it  may  call  for  a  very  substantial  amount  of 
initiative  and  independent  judgment.  Doubtless,  it  would 
be  well  if  every  operating  engineer  were  a  completely 
trained  engine-builder  familiar  with  the  theory  on  which 
the  machine  he  runs  is  constructed.  The  same  is  true  of 
the  bookkeeper.  It  would  be  highly  desirable  if  a  firm's 
books  could  be  both  constructed  and  carried  on  by  the 
same  person,  and  if  that  person  were  theoretically  capable 
of  devising  a  suitable  set  of  records  which  should  give 
effect  to  a  complete  system  for  recording  the  transactions 
of  the  concern.  Neither  of  these  things  is  ordinarily  pos- 
sible. Specialization  is  as  characteristic  and  as  necessary 
in  the  sciences  or  professions  which  record  the  results  of 
business  transactions  as  it  is  in  those  which  originate  or 
control  the  transactions. 

The  Accounting  Profession. 

As  long  as  business  was  of  a  single  type,  and  that  a 
comparatively  simple  one,  there  was  no  very  extended  field 
for  the  development  of  accounting  ideas.  This  is  not  at 
all  remarkable;  on  the  contrary,  it  is  the  same  situation 
which  has  existed  in  other  lines  of  work.  When  the  in- 
habitants of  the  United  States  lived  largely  in  log  cabins, 
there  was  not  much  demand  for  the  services  of  an  archi- 
tect. As  long  as  business  was  confined  to  simple  retail 
transactions  or  to  elementary  manufacturing  operations 
with  small  capital,  a  uniform  type  of  bookkeeping  could 
be  employed  and  the  bookkeeper,  if  intelligent,  could  be 
depended  upon  to  make  such  necessary  modifications  as  the 
special  circumstances  of  the  particular  business  seemed  to 
dictate.    This  condition  of  affairs  gradually  changed  as 


6  HENRY  PARKER  WILLIS 

the  amount  of  capital  employed  became  larger,  as  the  na- 
ture of  business  became  more  highly  specialized,  as  the 
corporation  took  the  place  of  the  individual  enterprise  or 
the  partnership,  and  as  the  distinction  between  govern- 
mental and  private  business  came  to  be  recognized.  Owing- 
to  this  process  of  development,  a  consequent  demand 
sprang  up  for  the  elimination  of  unnecessary  processes 
and  the  introduction  of  new  ones  that  had  become  neces- 
sary in  order  to  show  where  the  given  business  stood  at 
a  particular  moment.  Moreover,  as  business  has  become 
more  complex,  and  as  the  margin  of  profit  has  narrowed 
while  the  size  of  operations  has  greatly  increased,  greater 
and  greater  stress  has  been  put  upon  the  methods  of  get- 
ting a  system  of  records  which  would  show  in  the  most 
accurate  possible  way  what  was  the  result  of  a  given  trans- 
action or  operation.  It  was  not  of  very  great  importance 
to  a  firm  whether  it  made  two  or  three  cents  per  j'-ard  of 
cloth  when  it  sold  only  a  hundred  or  a  thousand  yards 
per  annum  and  when  this  was  but  one  element  in  the  busi- 
ness; but  it  was  of  very  great  importance  whether  the 
profit  was  two  or  three  cents  or  nothing  when  the  sales 
were  100,000  yards  or  1,000,000  yards  per  annum  and  when 
the  business  dealt  solely  in  such  cloth.  It  has  been  recog- 
nized, therefore,  that  it  is  well  worth  while  for  a  business 
concern  to  pay,  and  pay  handsomely,  for  the  very  best 
professional  advice  regarding  the  method  of  analyzing  and 
stating  its  daily  operations  or  of  organizing  its  business 
in  such  a  wslj  as  to  admit  of  a  comparison  of  its  opera- 
tions. In  consequence  of  this  strong  demand,  the  profes- 
sion of  accountancy  has  been  gradually  evolved. 

Development  of  Accountancy. 

The  discussion  of  bookkeeping,  sometimes  upon  a  plane 
and  from  a  standpoint  that  raised  it  practically  to  the 
level  of  the  science  of  accounting,  because  of  the  theoretical 
grasp  and  power  of  analysis  that  was  shown,  dates  back 


PRINCIPLES  OF  ACCOUNTINa 


hundreds  of  years.  It  has  not,  however,  been  until  com- 
paratively recently  that  a  distinct  differentiation  has  taken 
place  between  bookkeeping  and  accounting.  Up  to  compar- 
atively recent  times  the  routine  method  of  training  book- 
keepers was  followed  in  Great  Britain  and  then  such  book- 
keepers were  left  to  evolve  themselves,  if  they  could,  into 
accountants.  The  course  of  training  was  haphazard  and  in- 
adequate, and  as  a  result  there  was  gradually  developed  in 
England  a  demand  for  a  better  method  of  discipline  and  for 
a  public  recognition  of  the  profession  of  accountancy,  as 
well  as  for  its  regulation  and  control.  The  outcome  was  the 
establishment  of  associations  of  "chartered  accountants," 
the  members  of  which  speedily  came  to  have  a  high  profes- 
sional standing,  their  duties  being  those  of  examining  into 
the  condition  of  businesses,  ascertaining  the  situation,  re- 
porting thereon,  certifying  that  the  books  of  businesses 
had  been  accurately  conducted,  suggesting  changes  in 
methods  of  accounting,  recommending  new  modes  of  busi- 
ness administration,  etc.  Similar  influences  were  at  work 
in  the  United  States,  but  it  was  a  much  longer  time  be- 
fore there  was  any  legal  recognition  of  the  profession 
of  accountancy.  In  1896,  the  State  of  New  York 
passed  its  law  relating  to  certified  public  accountants,  and 
since  that  year  the  States  of  Pennsylvania,  Illinois,  Mary- 
land, California,  Washington,  New  Jersey,  Michigan,  Flor- 
ida, Utah,  Colorado,  Connecticut,  Georgia,  Louisiana,  Ohio 
and  Montana  have  legislated  along  similar  lines.  Measures 
designed  for  the  same  purpose  are  now  pending  in  other 
states,  and  will  gradually  be  adopted  until  in  every  state 
the  position  of  the  accountant  will  be  recognized  by  law, 
and  a  man  who  has  not  secured  a  certificate  by  passing 
the  requisite  examination  or  giving  evidence  of  equal  train- 
ing will  be  in  somewhat  the  same  position  as  the  medical 
student  or  graduate  who  has  not  taken  the  state  examina- 
tion exacted  of  all  who  wish  to  practice  medicine. 


8  HENRY  PARKER  WILLIS 

Scope  of  Accountancy  Examinations. 

Because  of  the  broad  scope  of  the  accountant's  labors, 
because  the  accountant  is  frequently  brought  into  contact 
with  large  problems  which  involve  some  knowledge  of  law 
and  other  allied  sciences,  it  is  customary  to  include  in 
these  examinations  matter  additional  to  that  which  prop- 
erly falls  within  the  scope  of  accounting  in  the  sense  in 
which  that  term  has  been  defined  in  preceding  pages. 
Practically  every  regular  examination  for  public  account- 
ants now  includes,  besides  questions  on  the  theory  of  ac- 
counts, problems  in  practical  accounting  and  auditing  and 
the  outlines  at  least  of  commercial  law.  Behind  these  is 
usually  the  requirement  of  a  high  school  education  or  its 
equivalent  and  in  some  cases  other  and  additional  train- 
ing. In  what  is  set  forth  in  the  following  pages,  the  effort 
is  made  to  present  in  outline  the  so-called  theory  of  ac- 
counts with  some  of  its  applications  in  practice.  The  sub- 
ject of  auditing  is  also  dealt  with  in  very  general  terms. 
By  auditing  is  meant  the  examination  of  records  or  ac- 
counts that  have  already  been  made  and  whose  correct- 
ness is  tested  and  certified  to  by  the  auditor.  The  auditor 
of  course  has  to  be  one  who  is  familiar  with  accounting 
and  bookkeeping,  although  his  work  is  not  primarily  con- 
structive but  chiefly  critical  and  analytical.  The  practical 
process  of  auditing  involves  the  use  of  various  methods 
and  expedients  which  save  time  or  serve  as  easily  avail- 
able tests.  This  phase  of  the  subject  therefore  cannot 
be  fully  discussed  in  the  treatment  which  is  here  intended, 
but  that  treatment,  as  already  indicated,  will  address  it- 
self to  the  setting  forth  of  the  principles  of  accounting 
and  the  way  in  which  they  are  practically  applied,  along 
broad  lines. 


THE  PRINCIPLES  OF  ACCOUNTING  9 

n.    CONSTRUCTION  OF  THE  ACCOUNT. 
Object  of  the  Account. 

As  we  have  seen,  the  fundamental  problem  of  the  ac- 
countant is  that  of  devising  a  suitable  system  for  record- 
ing business  facts  and  their  relations,  and  ''business,"  as  we 
have  noted,  consists  of  a  process  of  buying  and  selling — in  a 
w^ord,  exchanging.  In  the  simplest  sense  of  the  term,  then,  a 
*' record"  of  such  operations  would  be  found  in  a  mere 
statement  of  what  had  been  done,  written  down  in  diary 
form  with  no  attempt  at  classification.  Thus,  suppose  a 
boy  buys  a  stock  of  one  hundred  apples  for  which  he  pays 
$3.00  and  which  he  thinks  he  will  sell  at  five  cents  each. 
He  might  record  his  operations  as  follows: 

January  1,  Bought   100  apples  for  $3.00. 
January  2,  Sold  20  apples  at  5  cents  each. 
January  3,  Sold  40  apples  at  5  cents  each. 
January  4,  Sold  40  apples  at  5  cents  each. 

Here  would  be  a  mere  summary  statement  of  what  had 
been  done.  It  would  be  far  better  than  nothing  because 
it  would,  at  least  presumably,  be  an  accurate  and  detailed 
statement  of  just  what  the  boy  had  done.  If  this  were  sup- 
plemented by  any  additional  facts,  such  as  the  record  of 
the  number  of  apples  that  had  rotted  or  spoiled  and  had 
consequently  been  thrown  away  owing  to  inability  to  sell 
them,  it  would  give  a  fair  idea  of  the  whole  scope  of  the 
undertaking.  It  is  evident,  however,  that  if  the  transac- 
tions were  numerous  the  record  would  become  so  long  and 
complex  that  presently  it  would  of  itself  be  valueless,  be- 
cause it  would  not  carry  any  clear  idea  to  the  mind  of  the 
reader.  It  would  be  of  service  then  only  as  furnishing 
material  on  which  to  base  a  further  classification  or  ar- 
rangement of  the  facts  referred  to.  Such  a  classification 
might,  however,  easily  be  obtained. 


10  HENRY  PARKER  WILLIS 

Classification  of  Facts. 

The  most  obvious  idea  in  classifying  commercial  trans- 
actions is  to  separate  tliem  into  the  two  great  groups  of 
opposed  character  already  spoken  of — buying  and  selling. 
If  John,  the  boy  of  our  illustration,  should  do  this  at  the 
outset,  he  might  think  it  well  to  reserve  one  page  of  his 
notebook  for  "bought"  items  and  one  page  for  ''sold'* 
items.    In  that  case  his  operations  might  look  like  this: 

BOUGHT. 
January  1,  100  apples $3.00 

SOLD. 

January  2,  20  apples  at  5  cents $1.00 

January  3,  40  apples  at  5  cents 2.00 

January  4,  40  apples  at  5  cents 2.00 

John  would  now  have  a  separation  between  his  bought 
and  sold  items  w^hich  would  be  of  more  value  to  him  as 
his  transactions  became  more  and  more  numerous  and  in- 
volved more  and  more  kinds  of  commodities.  If,  for  ex- 
ample, he  extended  his  operations  to  oranges  and  bananas 
and  bought  the  various  kinds  of  fruit,  as  well  as  sold  them, 
on  different  days  or  some  of  each  on  the  same  day,  the 
classification  of  bought  and  sold  items  would  be  absolutely 
necessary,  while  he  would  find  it  further  desirable  to  group 
each  day's  transactions  separately.  At  the  end  of  a  week 
or  a  month,  by  going  through  his  bought  and  sold  records 
extending  over  the  period,  he  could  see  how  much  he  had 
expended  and  how  much  he  had  taken  in.  Supposing  that 
he  then  took  account  of  stock  and  found  what  balance, 
if  any,  of  the  various  kinds  of  fruit  remained  in  his  posses- 
sion, he  w^ould  have  a  substantially  clear  knowledge  of 
w^hat  the  result  of  the  month's  transactions  had  been. 

Losses  and  Gains. 

It  would  not  be  long  before  the  fruit  dealer,  or  anyone 
else  engaged  in  business,  w^ould  find  that  there  w^ere  a 
number  of  other  items  that  he  must  take  into  account  in 
addition  to  goods  and  money.     The  summary  record  of 


THE  PRINCIPLES  OF  ACCOUNTING  11 

transactions  already  described  would  throw  no  light  on 
anything  except  the  goods  he  dealt  in  and  the  money  he 
received.  And  even  if  it  were  supplemented  by  a  state- 
ment at  the  end  of  the  month  or  other  period  showing  just 
what  was  left  of  the  fruit,  the  statement  would  probably 
prove  to  be  imsatisfactory  as  a  genuine  analysis  of  John's 
operations.  He  would  find  that  in  the  course  of  his  sales 
he  had  to  take  account  of  the  fact  that  expenses  of  one 
kind  or  another  were  incurred  in  doing  the  business.  His 
food,  lodging,  clothing,  etc.,  might  be  reckoned  by  him  as 
incidental  expenses,  while  the  same  might  be  true  of  such 
fruit  as  spoiled  while  in  his  possession,  thereby  resulting 
in  a  loss.  As  a  result  of  considering  these  factors,  it  is 
probable  that  John  or  anyone  in  his  position  would  before 
long  be  inclined  to  modify  the  general  classification  of 
^'bought"  and  ''sold"  and  to  substitute  something  else  that 
would  be  more  inclusive.  What  would  this  be?  The  diffi- 
culty which  John  has  encountered  in  getting  a  true  idea 
of  his  business  in  relation  to  himself  is  found  in  the  fact 
that  the  classification  of  ''bought"  and  "sold"  merely 
takes  account  of  goods  obtained  or  disposed  of  and  money 
received  or  spent,  while  what  he  needs  is  a  statement  of  all 
items  of  cost  or  outlay  or  loss  involving  a  reduction  of  his 
resources  or  income  and  a  classification  of  all  items  of  re- 
ceipt or  gain  or  advantage  representing  such  income. 

Debtor  and  Creditor. 

The  terms  which  have  been  accepted  by  the  business 
world  as  the  conventional  designation  of  the  ideas  just 
set  forth  are  those  of  "debtor"  and  "creditor,"  usually 
abbreviated  to  "Dr."  and  "Cr."  By  these  terms  is  meant 
the  comparative  showing  of  advantage  and  sacrifice  to 
which  we  have  referred.  The  use  of  the  terms  can  be  illus- 
trated simply,  from  the  theoretical  standpoint,  by  a  further 
development  of  our  illustration  about  John  and  his  fruit. 
Let  us  suppose  that  during  John's  transactions  with  the 


12  HENRY  PARKER  WILLIS 

100  apples  wliicli  lie  has  bought,  he  iinds  that  10  of  them 
spoil  while  he  is  obliged  to  pay,  say,  50  cents  for  the  use 
of  a  stand  on  which  to  exhibit  his  fruit  to  passers-by. 
Now  what  are  John's  groupings  or  classifications  of  ad- 
vantage or  sacrifice?  He  has  purchased  100  apples  giving 
in  exchange  $3.00  in  money.  He  has  spent  50  cents  for 
*'rent."  He  has  lost  10  apples  without  any  return  and 
he  has  sold  90  apples  at  5  cents  each,  bringing  him  in  a 
gross  return  of  $4.50. 

It  is  evident  then  that  he  might  account  for  the  trans- 
actions he  has  carried  on  by  summarizing  at  the  end  of 
the  week  or  month  during  which  he  has  disposed  of  his 
apples  in  such  a  way  as  to  show  a  condensed  grouping  of 
income  and  outgo.  If  he  were  to  do  this  in  simple  form,  he 
might  make  the  following  showing:* 

DEBTOR. 

January  1,  100  apples $3.00 

January  1,  Rent 50 

January  31,  Apples  lost  30 

CREDITOR. 

January  2,  Apples  so4d  for  cash $1.00 

January  3,  Apples  sold  for  cash 2.00 

January  4,  Apples  sold  for  cash 1.50 

Balance  in  favor  of  creditor  side 70 

From  this  it  is  seen  that  John,  the  boy  of  the  illustra- 
tion, regards  himself  as  having  received  from  someone  else 
goods  (apples),  services  (rent),  and  at  the  same  time  he 
has  been  subjected  to  conditions  which  have  inflicted  on 
him  a  loss  of  10  apples  which  he  figures  at  the  cost  price 
of  these  apples  or  3  cents  each.  In  other  words  he  himself, 
or  his  business,  is  obliged  to  get  back  from  the  world  at 
large  enough  to  cover  the  items  of  goods,  services  and  loss. 
In  the  course  of  the  business  transactions  he  does  so  recover 
cash  and  is  therefore  credited  with  the  amount  of  cash 
thus  received,  and  therefore  furnished  to  the  business. 
The  difference  or  "balance"  simply  shows  whether  John 

*Assuming  that  the  apples  sold  are  not  raised  in  price  sufficiently  to  make 
up  for  .the  loss  through  deterioration. 


THE  PRINCIPLES  OF  ACCOUNTINa  13 

Smith's  classification  of  debtor  items  exceeds  or  is  less 
than  his  classification  of  credit  items.  Ordinarily  John 
Smith,  for  the  sake  of  convenience  would  be  likely  to  offset 
these  items  against  one  another  in  a  rather  more  compact 
fashion  and  he  would  want  to  affix  to  the  statement  some 
title  of  a  descriptive  character  indicating  what  the  state- 
ment was  about.  Such  a  statement,  might  be  made  out 
by  him  in  simple  form  as  follows : 

JOHN  SMITH— HIS  BUSINESS  FOR  JANUARY. 

Dr.  Cr. 

January  1,  100  apples $3.00    January  2,  Apples  sold,  cash. ..  .$1.00 

January  1,   Rent    50   January  3,  Apples  sold,  cash....  2.00 

January  31,  Apples  lost 30   January  4,  Apples  sold,  cash 1.50 

Balance 70 

Nature  of  the  Account. 

From  this  illustration  it  can  be  seen  what  is  the  nature 
of  the  account.  The  account  is  simply  a  condensed  and 
classified  statement  of  business  facts  leading  to  a  conclu- 
sion. That  conclusion  is  whether  one  or  the  other  of  the 
sides  or  classifications  in  the  account  indicates  an  excess 
of  advantage  or  sacrifice,  as  the  case  may  be.  The  account 
is  itself  a  classification — that  is  to  say,  it  is  about  some 
distinct  definite  thing.  As  presented  and  illustrated  above 
the  subject-matter  of  the  account  or  the  thing  to  which  it 
related  was  **John  Smith,  his  Business,"  and  the  conclu- 
sion at  which  it  was  sought  to  arrive  was  whether  the 
things  for  which  he  had  become  indebted  to  the  commun- 
ity, or,  in  other  words,  for  which  he  had  been  obliged  to 
pay  others,  were  superior  in  value  to  the  things 
for  which  he  had  been  paid  by  the  community  or  for  which 
he  had  received  cash  from  others.  The  classified 
statement  about  John  Smith  and  his  business  rendered  it 
possible  to  reach  this  conclusion  only  in  the  event  that  the 
system  of  classification  adopted  was  correct,  and  further 
in  the  event  that  the  given  items  were  recorded  correctly 
in  accordance  with  the  system  which  had  been  determined 


14  HENRY  PARKER  WILLIS 

upon.  It  is  obvious,  however,  that  tlie  idea  of  the  account 
may  be  broadened  or  narrowed  in  actual  practice  accord- 
ing to  the  particular  needs  of  the  matter  which  is  to  be 
dealt  with,  the  idea  of  the  account  and  the  theory  of  its 
application  to  the  recording  of  business  transactions 
being,  however,  kept  the  same  throughout.  In  the  illustra- 
tion given  above  the  effort  was  made  to  apply  the  idea  of 
the  account  to  business  as  a  whole,  and  this  was  undoubt- 
edly the  original  or  basic  idea  out  of  which  accounting  and 
bookkeeping  were  developed,  since  historically  the  at- 
tempt would  be  made  to  develop  a  system  showing  the 
results  of  business  transactions  in  general,  and  then  to  con- 
fine them  or  limit  them  to  particular  phases  of  the  under- 
taking. 

The  Accounting  System. 

Before  business  has  gone  very  far,  however,  it  becomes 
necessary  to  apply  this  idea  of  accounting  to  different 
phases  of  the  business  and  to  recognize  that  every  class 
of  transactions  must  be  looked  at  in  its  relation  to  the 
business  as  a  whole  but  must  at  the  same  time  be  treated 
by  itself.  This  is  merely  for  the  sake  of  convenience  and 
simplicity.  The  question,  therefore,  arises:  How  can  an 
accounting  system  or  system  of  accounts  be  devised  in 
order  to  show  not  merely  the  general  results  of  a  business 
but  also  the  effect  of  each  transaction  upon  the  general 
position  of  the  business  itself?  It  is  clear  that  such  a 
classification  of  accounts  might  be  worked  out  from  sev- 
eral diiferent  points  of  view  according  as  the  business  it- 
self varies  and  according  as  it  is  desired  to  show  one  thing 
or  another  more  clearly.  This  point  will  be  dwelt  upon 
more  at  length  later  in  the  present  volume.  For  the  mo- 
ment it  is  probably  clearest  to  take  one  type  of  business 
and  show  how  the  system  of  accounting  applicable  to  that 
business  is  worked  out.  There  is  general  agreement  that 
the  simplest  type  of  such  business,  from  the  theoretical 


THE  PRINCIPLES  OF  xALCCOUNTINa  15 

standpoint,  is  that  of  retail  trade.  It  may  be  asked  there- 
fore at  the  outset  how  many  classes  of  account  ought  to 
be  kept  by  a  retail  trader  like  John  Smith  whose  transac- 
tions have  already  been  illustrated.  The  first  thing  that  is 
sought  by  all  retail  traders  is  to  know  exactly  what  their 
business  as  distinguished  from  themselves  is  doing.  It 
is,  therefore,  necessary  to  regard  the  business  as  a  distinct 
unit  or  entity  separate  from  the  person  of  its  owner  who 
may  be  engaged  in  any  number  of  business  enterprises. 
This  implies  that  in  every  business  it  shall  be  assumed  at 
the  outset  that  the  concern  starts  with  a  given  amount  of 
funds  or  wealth  as  a  basis  for  tradmg  and  that  these  funds 
or  this  wealth  is  appropriated  exclusively  to  the  uses  of  the 
business  without  being  withdrawn  save  under  specified 
conditions  for  the  personal  purposes  of  the  proprietor. 
Such  an  assumption  gives  rise  to  an  account  which  is  usu- 
ally designated  as  ''capital  account,"  and  which  is  really 
the  account  of  the  business  considered  as  an  entity  in  rela- 
tion to  the  outside  world.  In  other  words,  this  capital  ac- 
count shows  the  relations  existing  between  the  business  and 
the  world  as  a  whole.  Since,  as  we  have  seen,  business  op- 
erations give  rise  to  an  increase  or  diminution  of  wealth,  it 
is  evident  that  at  the  close  of  a  business  period  it  is  desir- 
able to  have  some  account  showing  the  profit  or  loss  for  the 
business  period.  This  account  is  usually  named  exactly 
what  its  contents  imply — that  is,  "profit  and  loss.'' 
Since  the  sources  of  profit  and  loss  may  be  va- 
rious, there  may  be  an  advantage  in  sub-classifying 
this  account  or  in  establishing  others  of  the  same 
general  type,  but  designed  to  show  how  profits  or 
losses  arose.  Examples  of  such  are  seen  in  the  case  of 
such  matters  as  rent,  insurance,  etc.  All  of  these  ac- 
counts, illustrating  the  relationships  between  the  busi- 
ness or  the  proprietor  of  the  business  and  certain  more  or 
less  abstract  ideas  or  operations,  are  usually  termed 
"nominal  accounts."    The  word  "nominal"  is  used  in  des- 


16  HENRY  PARKER  WILLIS 

cribing  them  not  because  they  are  unimportant  but  be- 
cause they  are  accounts  that  indicate  the  relationship  of 
the  proprietor  or  the  business  with  certain  names  or  ideas. 

As  in  the  case  of  John  Smith's  dealings  in  fruit,  it 
would  not  be  enough  to  state  how  much  he  had  spent  or 
how  much  he  had  taken  in  in  cash  or  even  these  with  the 
addition  of  the  amount  of  his  expenses  for  the  month  or 
other  period,  because  he  might  have  goods  left  on  hand 
or  goods  that  had  spoiled  while  in  his  hands,  so  that 
the  mere  statement  of  the  amount  put  in  and  the  amount 
taken  out  in  cash  would  not  necessarily  show  his  exact  posi- 
tion at  any  given  moment.  It  is  always  important  to  a  busi- 
ness to  know  exactly  where  it  stands  with  reference  to 
cash  and  with  reference  to  goods.  Hence  in  every  retail 
business  there  are  found  accounts  designed  to  show  how 
the  stocks  of  certain  things  o"\;\Tied  by  the  business  have 
been  affected  by  various  transactions.  In  the  case  of  the 
retail  business  the  most  important  of  such  accounts  with 
things  are  ''cash"  and  ''goods"  or  "merchandise."  There 
may  be  others,  as  wall  be  seen  later.  Such  accounts  with 
actual  tangible  things  are  usually  called  "real"  or  "prop- 
erty" accounts. 

In  all  of  the  illustrations  that  have  been  given 
thus  far  it  is  assumed  that  every  transaction  was  made 
for  cash,  and  that  there  was  no  particular  object  in  know- 
ing the  names  of  those  with  whom  the  dealings  were  car- 
ried on.  Thus,  John  Smith,  the  fruit  merchant,  may  get  his 
stock  of  apples  from  a  wholesale  grocer,  and  neither  party 
to  the  transaction  may  care  to  record  the  name  of  the  other 
any  more  than  John  Smith  cares  to  record  the  names  of 
the  persons  who  pass  him  on  the  street  and  purchase 
apples  at  his  stand.  It  is  clear,  however,  that,  in  businesses 
which  are  operated  on  any  considerable  scale,  this  indif- 
ference as  to  names  would  not  exist,  for  two  reasons:  (ly 
In  many  cases  payment  would  not  be  directly  made  in 
cash  and  hence  it  would  be  necessary  to  have  some  record! 


THE  PRINCIPLES  OF  ACCOUNTING  17 

of  the  transaction,  while  (2)  the  individuals  with  whom 
dealings  were  carried  on  might  both  buy  from  and  sell  to 
the  concern  so  that  the  latter  would  want  to  know  the 
balance  of  the  dealings.  For  these  reasons  a  third  class 
of  accounts  will  be  found  in  the  accounting  system  of 
every  retail  trader.  This  third  class  includes  the  so-called 
"personal"  accounts;  that  is,  the  accounts  of  the  business 
with  various  individuals  or  persons. 

Accounts  Reviewed. 

Reviewing  what  has  been  said,  then,  we  may  state 
that  the  accounts  of  a  simple  form  of  business  are  class- 
ifiable under  three  heads:  (1)  Nominal  accounts  which 
keep  track  of  the  results  of  operations  and  relationships; 
(2)  real  accounts  which  keep  track  of  the  stocks  of  real 
objects,  including  money,  goods,  etc.,  o\\Taed  by  the  con- 
cern; and  (3)  personal  accounts  which  keep  track  of  the 
relationships  between  the  business  itself  and  various  in- 
dividuals with  whom  it  has  dealings.  Under  nominal  ac- 
counts we  class  capital,  profit  and  loss,  and  expense  of 
various  kinds;  under  real  we  class  cash,  goods,  etc.;  and 
under  personal  we  class  all  accounts  having  to  do  with  a 
distinct  individual  who  is  named.  The  object  of  clear  and 
good  accounting  is  to  show  at  any  time  the  exact  position 
of  the  business — that  is,  the  actual  capital  invested  in  it 
as  augmented  by  the  profit  or  diminished  by  the  loss  for 
a  given  period,  to  show  exactly  what  the  amount  of  this 
profit  or  loss  has  been  during  the  given  period  as  com- 
pared with  similar  periods  in  the  past  and  to  show  at  any 
given  moment  the  amount  that  the  concern  has  to  pay  to 
different  individuals  as  well  as  the  amounts  that  it  has  a 
right  to  claim  from  other  individuals. 

The  Accounts  of  John  Smith. 

Let  us  now  see  how  these  principles  would  work  out 
in  the  case  of  John  Smith,  the  fruit  vendor  whose  transac- 

B— VIII— 2 


18 


HENRY  PARKER  WILLIS 


tions  we  have  already  described  for  the  month  of  Jan- 
uary. We  saw  that  he  originally  bought  apples  to  the  ex- 
tent of  $3.00.  Let  us  suppose  that  this  is  the  total  amount 
that  he  has  available  for  his  business  operations  and  that 
he  distinctly  sets  the  sum  aside  as  a  basis  for  trading.  If 
he  were  to  organize  his  simple  transactions  upon  the  basis 
of  an  accounting  system  such  as  has  just  been  sketched, 
his  ** accounts"  before  he  had  bought  any  apples  would 
look  like  this: 

J.  SMITH,  CAPITAL  ACCOUNT. 


Dr. 

Cr. 

JJan.  1 

Cash 

$3.00 

1             II 

CASH. 
Dr. 

Cr. 

Jan.  1 


To  J.  Smith 


$3.00 


What  does  this  show?  Simply  that  the  business  con- 
sidered as  a  going  concern  is  credited  with  cash  because 
it  has  supplied  that  or  has  furnished  it  for  business  trans- 
actions. John  Smith,  Merchant,  has  furnished  the  busi- 
ness $3  of  capital  so  that  the  account  which  deals  with  cap- 
ital is  "credited"  w^ith  that  sum  because  it  has  furnished 
the  amount  for  business  operations.  In  the  same  way, 
the  cash  account  carried  on  its  Dr.  side  an  entry  of  $3,  indi- 
cating the  fact  that  the  stock  of  cash  has  been  established 
or  has  been  increased  by  the  sum  of  cash  which  has  been  put 
into  the  business  by  John  Smith.  Smith  might,  instead 
of  putting  up  the  "capital"  in  the  form  of  money  have 
put  it  up  in  the  form  of  goods.  In  that  event,  the  account 
which  w^ould  be  opened  at  the  start  would  be — not  cash — 
but  that  of  goods  and  merchandise,  which  would  shoAV  the 
amount  of  such  goods  put  into  the  business  in  the  form  of  a 
debtor  entry  corresponding  to  the  amount  thus  furnished. 

John  Smith  now  spends  his  cash  capital  for  apples — in 
other  words,  he  converts  his  cash  into  goods.  What  change 


THE  PRINCIPLES  OF  ACCOUNTINa 


19 


does  this  make  in  his  account  ?    It  affects  cash  in  the  fol- 
lowing way: 

CASH. 
Dr.  Cr. 


Jan.  1 


To  J.  Smith 


I  $3.00 


Jan.  1 


By  goods 


I  $3.00 


All  that  this  shows  is  that  the  cash  account,  which  got 
$3.00  from  Smith,  has  now  parted  with  it  by  reason  of  the 
fact  that  goods  have  been  received  by  the  business  in  ex- 
change for  such  cash.  Moreover,  since  the  business  has 
now  come  into  the  ownership  of  the  apples  or  goods,  a 
goods  or  merchandise  account  will  be  opened  as  follows: 


Dr. 


GOODS. 


Cr. 


Jan.  1    To  cash  for  apples 


$3  00     II 


There  has  now  been  no  change  whatever  in  the  capital 
account.  The  capital  remains  invested  in  the  business 
and  the  only  change  in  the  situation  is  that  the  items  ob- 
tained with  the  capital  have  changed  in  form,  becoming 
apples  instead  of  cash. 

We  saw  that  Smith  had  to  pay  50  cents  for  the  rent  of 
his  fruit  stand.  If  this  were  properly  recorded  it  would 
appear  in  an  account  as  follows: 


Dr. 


RENT. 


Cr. 


Jan.  1     To  use  of  premises 


$0.50 


The  account  headed  "Rent"  carries  the  use  of  premises 
for  January  upon  the  debtor  side  because  some  value  has 
been  received  by  the  business.  The  value  received  is  the 
actual  use  of  the  stand.  This  service  of  furnishing  the 
stand  to  the  business  or  allowing  the  stand  to  be  occupied 
is  as  much  an  element  of  value  as  the  apples  that  were  re- 
ceived by  the  concern.  The  fact  that  the  apples  had  been  re- 
ceived was  indicated  by  an  entry  on  the  debtor  side  of  the 


20 


HENRY  PARKER  WILLIS 


goods  account.  In  the  same  way  the  fact  that  the  use  of 
premises  has  been  received  is  carried  on  the  debtor  side 
of  the  rent  account.  Of  course  Smith  has  to  pay  for  his 
rent  in  cash  and  that  implies  that  at  whatever  period  in 
the  month  he  makes  payment  he  will  reduce  the  cash  on 
hand.  Supposing  that  he  makes  payment  in  advance  on 
January  1,  he  can  do  so  out  of  the  first  proceeds  of  his 
sales.  In  our  former  illustration  we  assumed  that  on 
January  1  he  sold  20  apples  at  5  cents  each,  making  $1. 
This  evidently  meant  that  at  the  close  of  business  on 
January  1  he  had  reduced  the  stock  of  goods  or  apples  on 
hand  by  20,  valued  at  $1.00  for  selling  purposes,  had  cor- 
respondingly increased  the  stock  of  cash  and  had  inci- 
dentally paid  50  cents  for  rent.  It  is  clear  that  the  rent 
account,  which  has  already  been  entered  with  the  use  of 
premises  for  January,  is  not  affected  by  these  transac- 
tions. Cash  and  goods  then  are  the  only  accounts  that  are 
changed  and  they  will  stand  as  follows: 

CASH. 


Dr. 

Cr. 

Jan.  1 
Jan.  1 

To  J.  Smith 
"  goods 

$3.00 
1.00 

Jan.  1 
Jan.  1 

By  goods 
"    rent 

$3.00 
.50 

Dr. 

GOODS. 

Cr. 

Jan.  1     To  cash  for  apples 


$3.00       Jan.  1     By  cash 


$1.00 


Smith's  subsequent  transactions,  as  we  saw,  were  all  of 
this  same  description;  that  is,  sales  of  apples  for  cash,  so 
that  the  entries  are  thereafter  all  the  same  so  far  as  sales 
are  concerned.  We  saw,  however,  that  at  the  end  of  the 
month  he  found  10  apples  in  an  unsalable  condition.  How 
should  he  account  for  these  ?  He  could  do  so  only  by  open- 
ing an  account  for  that  special  purpose  or  by  representing 
the  loss  thus  incurred  as  an  entry  under  his  goods  ac- 
count. Supposing  that  he  were  to  adopt  the  latter  method, 
what  change  would  it  make  in  the  goods  account?    He 


THE  PRINCIPLES  OF  ACCOUNTING 


21 


would  have  to  regard  the  apples  as  having  been  sold  or 
parted  with  and  consequently  would  be  obliged  to  credit 
goods  account.  There  would,  however,  be  nothing  coming 
into  the  business  in  return  and  as  a  matter  of  fact  he 
might  find  it  more  expedient  to  represent  this  loss  of 
apples  under  the  head  of  a  special  account  for  the  purpose 
or  under  the  head  of  the  general  profit  and  loss  account. 
If  he  did  the  latter,  how  would  the  profit  and  loss  account 
look?    As  follows: 

PROFIT  AND  LOSS. 


Dr. 


Cr. 


Jan.  31    To  loss  on  fruit 


$0.30 


Here  the  apples  are  represented  on  the  debtor  side  of 
the  profit  and  loss  account  because  the  abstract  concep- 
tion profit  and  loss  is  thought  of  as  having  received  some- 
thing from  the  business.  It  has  received  the  apples  that 
were  lost  or  spoiled — that  is  to  say  it  is  responsible  to  the 
business  for  the  sacrifice  involved  in  losing  the  apples. 
But  at  the  end  of  the  month  is  there  not  some  other  entry 
to  be  made  in  profit  and  loss?  Obviously  that  must  be 
done  if  the  business  has  gained  anything.  What  has  the 
business  gained?  It  has  sold  all  of  the  good  apples  re- 
maining after  deducting  those  that  were  spoiled.  It  has 
consequently  received  a  given  amount  of  cash  in  exchange 
while  it  has  no  goods  on  hand.  It  is  possible,  therefore, 
to  contrast  the  position  of  the  business  at  the  end  of  the 
month  very  exactly  with  its  position  at  the  opening  of  the 
month  by  consulting  the  goods  account.  The  account 
(supposing  the  transactions  to  have  been  the  same  as 
those  repres_ented  on  page  12')  will  be  as  follows : 


Dr. 


GOODS. 


Cr. 


Jan. 

1 

To  cash 

$3.00 

Jan. 
Tan. 
Jan. 

1 

3 
4 

By  cash 
"    cash 
"    cash 

$1.00 
2.00 
1.50 

Jan. 

31 

"    loss  on 

spoiled  goods 

.30 

22 


HENRY  PARKER  WILLIS 


From  this  it  is  seen  that  whereas  the  total  amount  of 
cash  exjDended  for  the  original  stock  of  goods  (apples) 
was  $3.00  the  total  amount  which  has  nominally  been  real- 
ized from  the  sale  of  these  same  goods  or  such  of  them  as  re- 
main fit  for  consumption  is  $4.80.  The  goods  or  apples 
have  all  been  disposed  of  so  that  none  remain  on  hand 
available  for  sale.  It  is  clear  then  that  the  difference  be- 
tween the  two  sides  of  the  goods  account  represents  the 
excess  for  which  the  apples  have  been  sold  over  and  above 
the  price  that  was  originally  paid  for  them.  This  differ- 
ence is  seen  to  be  $1.80  in  favor  of  the  creditor  side  and 
this  represents  the  income  or  profit  for  the  business.  To 
complete  profit  and  loss  account  we  shall  now  simply  credit 
that  account  with  the  $1.80  which  represents  the  balance 
in  goods  account  (having  of  course  debited  goods  with  this 
same  amount),  while  on  the  debtor  side  we  shall  enter  all 
those  entries  which  represent  losses  or  expenditures.  In 
the  illustration  w^e  have  chosen,  the  only  losses  or  outlays 
are  those  w^hich  arose  from  the  spoiling  or  decay  of  fruit 
and  the  payment  of  rent  as  an  expense.  The  profit  and  loss 
account  then  will  appear  as  follows: 

PROFIT  AND  LOSS. 


Dr. 

Cr. 

Jan.    1    To  rent  for  month 
Jan.  31      "    loss  on  fruit 

$0.50 
.30 

Jan.  31  By  goods,  gross 
profit  on  sales 

$1.80 

The  difference  between  the  debtor  and  creditor  sides 
of  the  profit  and  loss  account  is  thus  seen  to  be  $1.00.  This 
then  is  the  net  profit  or  gain  on  the  business  after  allow- 
ing for  losses  and  it  may  be  transferred  to  J.  Smith's  cap- 
ital account  as  a  credit  representing  the  amount  of  cash 
earnings  which  have  been  realized  and  added  to  the 
amount  originally  in  the  business.  As  that  amount  was 
$3.00  his  net  worth  should  now  be  $4.00.  We  may  now  gath- 
er the  accounts  of  John  Smith  together  in  the  following 


THE  PRINCIPLES  OF  ACCOUNTINa 


23 


form,  employing  however  certain  rulings  and  notations 
which  will  be  explained  in  Section  III  (pp.  35,  ff.). 

CAPITAL. 


Dr. 

Cr. 

Jan.  31 

To  balance  carried  dowa 

$4.00 

Jan.    1 
Jan.  31 

Feb.    1 

By  cash 
"   profit  and   loss 

By  balance  brought 
down 

$3.00 

$4.00 

1.00 

$4.00 

$4.00 

CASH. 


Dt. 


Cr. 


Jan.  1 
Jan.  1 
Jan.  3 
Jan.  4 


Feb.  1 


To  J.  Smith 
"   goods 
"    goods 
"    goods 


To  balance  brought  down 


$3.00 
1.00 
2.00 
1.50 


$7.50 


4.00 


Jan.  1 
Jan.  1 

Jan. 31 


By  goods 
"   rent 

"    balance  carried  down 


$3.00 
.50 

$4.00 


$7.50 


Dr. 


GOODS. 


Cr. 


Jan.    1 
Jan. 31 


To  cash 
"    profit  and  loss 


$3.00 
1.80 

Jan.    1 
Jan.    3 
Jan.    4 
Jan. 31 

$4.80 

By  cash 
"  cash 
"  cash 
"  loss  on  spoiled  goods 


$1.00 

2.00 

1.50 

.30 


$4.80 


RENT. 


Dr. 

Cr. 

Jan.    1 

To  use  of  premises 

$0.50 

Jan. 31 

By  balance  to 
profit  and  loss 

$0.50 

$0.50 

$0.50 

PROFIT  AND  LOSS. 


Dr. 

Cr. 

Jan.    1 

To  rent  for  month 
"    loss    on    fruit 
"    balance  to  capital 

$0.50 

.30 

1.00 

Jan. 31 

By  goods,  gross 
profit  on  sales 

Jan.  31 
Jan.  31 

$1.80 

$1.80 

$1.80 

It  will  be  observed  that  the  sum  total  of  the  debtor 
entries  in  these  accounts  of  John  Smith's  for  the  month 
of  January,  total  the  same  as  the  creditor  entries.  His 
assets  at  the  end  of  the  month  consist  simply  of  cash  just 
as  they  did  at  the  beginning  and  the  increase  in  cash  is 
equal  to  the  increase  in  the  capital  or  net  worth  of  John 
Smith.     Every  transaction  was  analyzed  into  two  parts 


24  HENRY  PARKER  WILLIS 

and  gave  rise  to  two  entries,  one  on  the  debtor  side  of 
some  account  and  one  on  the  creditor  side  of  some  account. 
This  is  what  is  meant  by  the  ''double  entry"  system  or 
principle  in  accounting  and  bookkeeping.  Every  trans- 
action gives  rise  to  two  opposed  entries  in  the  accounts. 
Wlien  we  say  ''two  entries"  we  do  not  necessarily  mean 
two  in  the  literal  sense  but  rather  two  opposing  groups 
of  entries.  A  transaction  may  be  analyzed  into  one  entry 
on  the  debtor  side  of  the  books  and  two  or  more  on  the 
creditor  side  or  vice  versa.  The  principle  simply  requires 
that  the  total  value  of  the  entries  shall  be  the  same  on  the 
debtor  side  of  the  accounts  as  on  the  creditor.  In  closing 
the  accounts  for  the  month  the  process  of  completing  the 
entries  and  transferring  balances  gives  rise  to  various 
technical  processes  necessitated  by  bookkeeping  practice. 
These  will  be  sketched  in  the  following  section. 

m.  KEEPING  THE  BOOKS. 

Practical  Problems. 

Supposing  that  business  has  developed  a  perfect  theo- 
retical system  of  keeping  its  accounts,  the  question  will 
always  arise  in  every  concern  how  practically  to  carry  on 
the  actual  records  in  such  a  way  as  to  save  time  and  labor 
so  far  as  possible  and  at  the  same  time  to  insure  the  max- 
imum of  correctness  and  detail.  Every  bookkeeping  sys- 
tem is  more  or  less  of  a  compromise  because  no  concern 
is  willing  to  spend  more  than  is  necessary  upon  the  keep- 
ing of  elaborate  records  however  desirable  such  records 
might  theoretically  be.  It  is  true,  however,  that  many 
concerns,  accustomed  to  old  and  traditional  methods  of 
bookkeeping  and  accounting,  do  maintain  a  variety  of 
records  that  are  of  no  special  service,  while  on  the  other 
hand  some  firms,  in  their  desire  to  simplify  and  avoid  the 
maintenance  of  unnecessary  records,  cut  out  links  in  the 
accounting  system  that   cannot  well  be   dispensed   with. 


THE  PRINCIPLES  OF  ACCOUNTINa  25 

This  is  unfortunate  from  a  good  many  standpoints,  be- 
cause the  ordinary  concern  is  frequently  obliged  to  make 
use  of  its  records  of  past  transactions,  either  for  the  pur- 
pose of  establishing  various  points  in  legal  proceedings  or 
of  ascertaining  what  its  practice  has  been  on  former  oc- 
casions where  given  problems  were  presented,  or  for  the 
purpose  of  convincing  a  prospective  buyer  of  the  exact 
nature  of  the  profits  that  have  been  realized.  It  is  not 
possible  to  lay  down  any  hard  and  fast  lines  or  rules  with 
reference  to  the  exact  number  of  books  or  records  that  a 
concern  shall  keep  or  to  specify  which  one  can  safely  be 
omitted,  or  to  indicate  certain  of  them  as  absolutely  nec- 
essary and  indispensable.  Experience  shows  what  books 
must  be  kept  by  a  concern  and  what  ones  may  with  profit 
be  added;  it  also  indicates  the  points  at  which  the  con- 
cern may  more  or  less  readily  dispense  with  certain 
classes  of  records.  Something  further  will  be  said  on  these 
points  later  on  in  our  treatment.  At  this  point  it  is 
enough  to  say  that,  contrary  to  many  assertions  on  the 
subject,  it  is  not  possible  to  lay  down  any  general  system 
with  regard  to  this  matter  but  that  there  are,  however, 
certain  kinds  of  books  which  are  traditional  or  conven- 
tional and  which  are  found  in  some  form  in  the  majority  of 
concerns. 

Traditional  Books. 

The  traditional  books  that  are  carried  on  by  the  or- 
dinary retail  concern  are  the  ^'day  book,''  '' journal' '  and 
^^ ledger."  Why  should  these  have  come  into  such  general 
use  and  why  are  they  employed?  Their  use  is  as  already 
suggested  largely  a  matter  of  convention  and  convenience. 
This  will  be  seen  by  a  brief  sketch  of  the  contents  of  these 
books.  As  was  noted  in  our  early  analysis  of  the  transac- 
tions of  John  Smith,  fruit  vendor,  it  might  easily  have 
been  determined  by  Smith,  had  he  been  so  disposed,  to  get 
along  with  merely  a  diary  or  record  indicating  the  character 


26  HENRY  PARKER  WILLIS 

and  extent  of  his  transactions.  We  saw  that  in  his  case, 
with  very  simple  operations,  that  might  have  sufficed.  Had 
he  done  so,  he  might  have  given  to  his  record  the  name  *'Day 
Book."  A  day  book  is,  as  ordinarily  employed,  nothing 
more  than  a  summary  or  outline  statement  of  the  various 
transactions  of  the  concern,  they  being  recorded  there  for 
the  sake  of  convenience,  in  the  order  in  which  they  occur 
and,  in  small  businesses,  without  any  effort  at  classification. 
A  day  book  is  usually  ruled  with  columns  designed  to  en- 
able the  proper  recording  of  figures  and  their  totaling.  In 
other  words  it  is  nothing  more  than  a  blank  or  record 
book  suitably  ruled  for  the  sake  of  convenience.  Suppose  a 
concern  had  a  month's  transactions  thus  recorded  in  a 
day  book.  It  would  have  no  classification  or  grouping  of 
the  transactions,  but  on  the  contrary  it  could  not  see  the 
results  of  what  had  been  going  on,  even  in  any  one  phase. 
For  instance,  if  Richard  Brown  had  bought  steadily  of  the 
concern  every  day  for  a  month  and  others  had  done  the 
same,  the  transactions  of  Brown  and  others  would  simply 
be  set  down  in  chronological  order.  If  a  system  of  ac- 
counting were  to  be  employed,  the  segregation  of  the  va- 
rious items  and  their  classification  as  accounts  would  be 
necessary.  This  could  be  done  by  simply  transferring  the 
items  from  the  day  book  to  another  book  in  which  the 
proper  classification  would  be  made. 

The  Ledger. 

The  book  to  which  such  transfers  would  be  made  is 
called  the  "Ledger."  The  ledger  contains  no  new  facts 
that  are  not  recorded  in  the  day  book,  but  merely  presents 
the  same  facts  rearranged  in  such  form  as  may  be  desired. 
The  form  ordinarily  desired  is  a  grouping  under  the  real, 
nominal  and  personal  accounts  that  have  already  been 
described  in  Section  II.  Every  ledger,  therefore,  contains 
the  customary  nominal  accounts  such  as  capital,  profit 
and  loss,  etc.,  the  customary  real  accounts  such  as  cash, 


THE  PRINCIPLES  OP  ACCOUNTING  27 

goods,  etc.,  and  then  as  many  personal  accounts  as  there 
are  persons  with  whom  the  firm  has  had  dealings  which 
it  desires  to  record  in  this  detailed  way.  The  ledger  then 
is  merely  a  book  in  which  the  transactions  of  the  day  book 
are  assorted  under  the  heads  Capital,  Profit  and  Loss, 
Cash,  Goods,  Eichard  Brown,  etc.,  etc.,  etc.  The  process 
of  transferring  the  items  from  the  day  book  or  any  other 
book  to  the  ledger,  is  called  ''posting,"  and  the  ledger  is 
said  to  be  "posted"  when  the  entries  that  have  been  made 
in  other  books  have  been  transferred  to  its  pages.  The 
process  of  posting  evidently  implies  the  recognition  of  the 
different  accounts  that  are  affected  by  a  given  transaction 
and  the  transference  of  the  proper  entry  to  every  account 
which  is  thus  thereby  altered.  In  some  cases  this  is  not 
an  easy  thing  to  do  correctly,  while  it  may  be  that  the  day 
book  does  not  give  as  full  information  about  the  nature 
of  the  transfers  made  as  is  desired.  For  that  reason,  an- 
other book  is  frequently  introduced,  intermediate  betAveen 
the  day  book  and  ledger.    This  is  called  the  "Journal." 

The  Journal. 

The  journal  is,  as  already  indicated,  little  more  than 
a  means  of  sifting  out  the  transactions  rather  better  than 
could  be  done  mentally,  and  serves  the  purpose  of  com- 
paring the  items  for  transfer  by  stating  them  in  different 
form.  There  might  be  no  particular  reason  for  using  the 
journal  if  the  nature  of  the  entry  in  the  day  book  could 
always  be  recognized  at  sight  and  a  corresponding  trans- 
fer to  the  ledger  could  be  made.  But,  as  already  indicated, 
this  is  not  practicable,  and  hence  the  use  of  the  journal.  To 
the  beginner  in  accounting  or  bookkeeping  the  use  of  the 
journal  is  rather  necessary  because  it  serves  as  a  means 
of  analysis  and  enables  the  testing  of  the  work  as  well  as 
its  review  for  the  purpose  of  ascertaining  w^hether  errors 
have  slipped  in  or  not.  We  shall  speak  of  the  journal 
(and  of  the  other  books)  more  fully  at  a  later  point.    At 


28  HENRY  PARKER  WILLIS 

tliis  point  it  is  not  necessary  to  do  more  than  to  indicate 
clearly  the  difference  in  the  way  in  which  given  entries 
appear  in  the  day  book,  journal  and  ledger.  For  example, 
the  following  would  be  a  typical  day  book  entry: 

Jan.  1   Bought  goods  of  Richard  Brown $100 

In  the  journal  this  would  appear  as  follows; 

Jan.  1 1  Goods  account — Dr.  | 

I    To  Richard  Brown  |$100.00        $100.00 

This  transaction  is  said  to  have  been  '* journalized." 
What  has  been  done  has  been  to  indicate  that  the  transac- 
tion "Bought  goods  of  Richard  Brown"  implies  that  an 
entry  will  be  made  on  the  debtor  side  of  goods  account 
and  a  corresponding  entry  on  the  creditor  side  of  Richard 
Brown's  account.  This  is  for  the  reasons  already  suffic- 
iently stated.  Goods  account  is  increased  by  the  amount 
of  goods  received  and  is  therefore  a  "debtor"  to  the  con- 
cern, while  Richard  Brown  has  furnished  the  goods  and 
is  therefore  "creditor"  of  the  concern  to  an  equal  amount. 
The  journalizing  is  merely  the  analysis  of  the  transaction, 
to  indicate  that  the  accounts  affected  or  modified  are 
"Goods"  and  "Richard  Brown,"  and  that  an  entry  of  $100 
is  made  in  the  one  on  the  debtor  side  and  in  the  other  on 
the  creditor  side.  If  the  item  thus  journalized  were  to  be 
transferred  to  the  ledger  it  w^ould  appear  thus: 

GOODS. 

Dt. Cr. 

Jan.  1  ITo  Richard  Brown  |$100.00 1|  j 

RICHARD  BROWN. 

Dr. Cr^_ 

I  I  II  Jan.  1 1  By  goods 

I  I  II  I  /  $100.00 

Evidently  here,  as  remarked  before,  the  service  of  the 
journal  is  merely  that  of  convenience.  There  is  in  this 
case  no  other  reason  for  its  maintenance  although  in  the 
case  of  some  other  transactions  the  reason  for  keeping 


THE  PEINCIPLES  OP  AOCOUNTINa 


29 


it  is  more  obvious  as  will  be  seen  later  on.*    Sample  pages 
of  day  book  and  journal  are  seen  below. 

Classification  of  Books. 

We  stated  earlier  in  this  discussion  that  the  books, 
day  book,  journal  and  ledger,  were  conventional  or  cus- 
tomary books.  In  other  words,  the  necessities  of  a  busi- 
ness may  be  such  as  to  indicate  that  these  books  are  not 
adequate  or  sufficient  or  that  some  of  them  may  safely  be 
omitted.     For  instance,  it  is  entirely  conceivable  that  a 

Sample  Page  of  Day  Book. 


1910 

Jan.  1 
"  1 
"  1 
"    1 


John  Smith  begins  business  with  cash  capital, 

Bought  goods  for  cash 

Sold  goods   for   cash 

Paid  rent  in  cash,  for  January... 


$3.00 

3.00 

1.00 

.50 


Sample  Page  of  Journal. 


Led. 
Fo. 

Dr. 

Cr. 

1910 
Jan.  1 

Cash  acct. — Dr. 

To  Jo'hn  Smith  Capital  acct. 

$3.00 

3.00 

1.00 

.50 

$ 
3.00 

"    1 

Goods  acct. — Dr. 
To  cash 

3.00 

"    1 

Cash  acct. — Dr. 
To  goods  acct. 

1.00 

"     1 

Rent  acct.— Dr. 
To  cash 

.50 

Note.  Dates  of  transactions  are  placed  in  the  column  at  the  extreme  left. 
As  transactions  are  analyzed  for  the  ledger  the  debtor  entry  for  each  trans- 
action is  entered  on  the  upper  line  wfth  the  corresponding  creditor  entry  (or 
entries)  below.  The  sums  entered  are  written  in  separate  Dr.  and  Cr.  columns 
at  the  right.  The  column  headed  "Led.  Fo."  (signifies  Ledger  Folio)  is 
intended  for  the  references  to  ledger  pages  where  the  transactions  are  posted. 

*The  illustrative  accounts  presented  in  Section  II,  p.  23,  are  ledger  accounts. 


30  HENRY  PARKER  WILLIS 

business  might  be  so  simple  as  to  dispense  entirely  with 
the  day  book  and  journal.  But  the  probability  is  that  the 
reverse  will  be  the  case;  that  is,  that  more  rather  than  less 
books  will  be  needed.  What  direction  will  this  increase 
in  books  and  records  take  ?  Obviously  it  may  take  the  di- 
rection of  adding  or  developing  some  entirely  new  books, 
or  it  may  take  the  direction  of  sub-classifying  the  old 
ones.  The  latter  case  is  the  simplest  and  most  easily  un- 
derstood and  will  therefore  be  dealt  with  first.  It  is  easy 
to  see  that  the  mere  work  of  recording  transactions  in  the 
day  book  may  be  very  heavy  indeed  where  the  transac- 
tions are  exceedingly  numerous.  It  may  be  so  heavy  as 
to  make  it  desirable  to  have  two  or  more  day  books,  in 
order  that  two  or  more  clerks  may  work  simultaneously 
at  the  recording  of  the  transactions.  If  that  were  the 
case,  it  would  be  entirely  possible  to  have  the  two  or  more 
clerks  working  at  exactly  the  same  duty — the  recording 
of  all  kinds  of  transactions  indiscriminately  in  chronolog- 
ical order.  This  would  have  the  disadvantage  of  render- 
ing it  hard  to  journalize  or  post  from  tw^o  or  more  books 
and  yet  have  the  journalizing  or  posting  done  in  chrono- 
logical order  in  the  journal  or  ledger.  Moreover,  a  val- 
uable opportunity  for  classifying  transactions  would  have 
been  lost.  A  better  classification  would  be  made  by  in- 
stituting a  "sales  day  book"  and  ''purchases  day  book" 
or  ''purchases  book."  In  the  sales  day  book  would  then  be 
recorded  all  selling  transactions.  In  the  purchases  book 
w^ould  be  recorded  all  buying  transactions.  There  would 
thus  be  a  rough  classification  of  transactions  and  in  addi- 
tion the  element  of  greater  convenience  w^ould  have  been  at- 
tained. There  would  be  no  reason  w^hatever  why  the  sales 
day  book  should  not  be  subdivided  to  any  extent  by  estab- 
lishing a  sales  day  book,  say,  for  every  department  of  the 
business.  Thus,  if  the  concern  were  a  department  store,  it 
might  theoretically  have  a  sales  day  book  for  its  grocery 
department,  one  for  its  dry-goods  department  and  one  for 


THE  PRINCIPLES  OF  ACCOUNTINa  31 

its  furniture  department.  In  the  same  way,  there  might 
be  purchases  books  for  each  of  these  departments.  The 
subdivision  here  is  merely  a  matter  of  convenience  and  in- 
volves no  change  of  theory.  All  of  these  books  are  books 
of  "original  entry,"  and  in  all  bookkeeping  transactions 
involving  the  whole  business  of  the  concern  they  should 
simply  be  regarded  as  mere  subdivisions  of  the  original 
day  book  and  as  constituting  together,  when  taken  as  a 
whole,  exactly  the  same  thing  in  relation  to  the  business 
and  its  accounting  system  as  the  original  day  book. 

Classes  of  Ledgers. 

What  has  been  said  of  the  day  book  applies  to  the 
ledger  in  exactly  the  same  way.  In  a  large  concern,  it 
may  be  very  difficult  to  make  use  of  the  ledger  in  such  a  way 
as  to  get  all  transactions  quickly  and  jDromptly  posted,  be- 
cause the  work  is  too  much  for  one  man.  Similarly  it  may 
be  desirable  to  have  the  ledger  in  more  than  one  place  at 
the  same  time,  so  that  more  than  one  actual  book  is 
needed.  The  classification  of  ledgers  is  therefore  custo- 
mary. This  classification  may  proceed  upon  the  same  lines 
as  did  that  of  the  day  book — there  may  be  purchases  ledg- 
ers, sales  ledgers,  etc.,  to  any  number.  The  purchases 
ledgers  would  simply  include  accounts  with  individuals 
from  whom  purchases  had  been  made.  The  sales  ledgers 
would  include  accounts  with  individuals  to  w^hom  sales 
had  been  made.  Or,  for  the  sake  of  convenience  it  might 
simply  be  desirable  to  have  the  ledgers  alphabetically  ar- 
ranged. Thus  there  might  be  two  ledgers — one  containing 
all  accounts  beginning  with  a  letter  from  A  to  M,  the 
other  including  all  accounts  beginning  with  a  letter  from 
N  to  Z,  or  if  the  business  required  it  there  might  be  24 
ledgers  each  including  the  accounts  beginning  with  a 
letter  of  the  alphabet,  and  so  on.  All  this  is  merely  matter 
of  detail.  It  is  clear,  however,  that  no  matter  how  exten- 
sive the  business  may  be  it  will  ultimately  desire  to  have 


32  HENRY  PARKER  WILLIS 

the  results  of  its  accounting  condensed,  since  the  final  ob- 
ject of  all  accounting  is  to  show  net  results.  This  means 
that  somewhere  or  other  the  so-called  nominal  accounts, 
which  show  the  changes  in  capital,  profit  and  loss,  etc., 
must  be  combined.  This  is  done  in  what  is  usually  called 
the  ''general  ledger."  In  this  general  ledger  are  ordina- 
rily represented  the  combined  results  of  the  other  ledgers, 
as  purchases  ledger,  sales  ledger,  etc.,  or  "A"  ledger,  "B" 
ledger,  etc.  By  opening  an  account  with  each  of  these 
ledgers  in  the  general  ledger,  there  may  be  presented  in 
the  general  ledger  the  combined  results  of  the  others  and 
along  with  them  are  given  the  general  or  nominal  ac- 
counts which  apply  to  the  whole  of  the  business,  as  cap- 
ital, profit  and  loss,  etc.  In  any  bookkeeping  or  account- 
ing system,  the  whole  set  of  ledgers  is  simply  treated  as  a 
unit  just  as  would  have  been  done  with  the  original  simple 
form  of  ledger,  in  which  all  ledger  accounts  were  consoli- 
dated into  one  book.  Where  the  general  ledger  is  used, 
this  gives  in  summarized  form  the  results  of  all  the  other 
ledgers  and  in  such  a  case  the  general  ledger  stands  in  the 
same  position  as  did  the  original  ledger.  The  sub-classi- 
fied ledgers  are  then  nothing  more  than  books  kept  for 
the  sake  of  convenience  in  making  records. 

While  there  is  no  reason  why  the  journal  should  not  be 
sub-classified,  and  as  many  journals  kept  as  there  are  sub- 
divisions of  the  day  book,  that  is  not  usually  necessary, 
and  except  under  special  conditions,  which  may  be  referred 
to  at  a  later  point,  the  journal  usually  retains  its  position 
as  a  single  intermediary  book. 

Other  Books. 

As  has  been  seen,  the  most  obvious  and  natural  classi- 
fication of  books  which  suggests  itself  in  the  case  of  the 
large  business  is  that  which  grows  out  of  the  division  of 
the  various  books  for  reasons  of  convenience  as  indicated. 
But  this  is  by  no  means  the  only  way  in  which  books  may  be 


THE  PRINCIPLES  OF  ACCOUNTINa  33 

added  to  the  number.    For  example,  it  may  easily  be  that 
a  ledger  account  becomes  so  long  and  so  highly  compli- 
cated as  to  make  it  desirable  that  this  account  shall  be 
taken  out  of  the  ledger  and  nothing  entered  in  the  actual 
ledger  itself  except  totals  for  given  periods.    The  best  ex- 
ample, perhaps,  of  this  kind,  is  seen  in  the  general  use  of 
the  ''cash  book."  Where  a  cash  book  is  kept,  as  it  usually 
is,  it  is  nothing  more  than  the  ledger  cash  account  bound 
up  by  itself  and  treated  as  an  independent  book.    This 
may  be  done  for  exactly  the  same  reason  which  led  to  the 
original  sub-classification  of  the  day  book.    It  may  be  de- 
sirable to  have  the  cash  book  broken  up  so  that  several 
persons  can  work  on  it,  or  at  all  events  to  have  it  separated 
from  the  ledger  so  that  access  to  it  can  be  easier  and  so 
that  a  long  and  very  detailed  account  need  not  be  kept  in  the 
ledger.    Exactly  the  same  thing  that  is  true  of  cash  may 
be  true  of  any  other  ledger  account — that  is   to   say,   a 
special  book  may  be  designated  for  the  keeping  of  that 
account.    The  two  books  which  are  customarily  seen  are 
the  so-called  "bills  receivable"  and  "bills  payable"  books, 
these  books  being  records  of  the  bills  receivable  which  the 
firm  owns,  or  the  bills  payable  for  which  it  has  rendered 
itself  liable  but  which  it  desires  to  have  recorded  in  con- 
venient form  with  all  particulars  of  the  date  when  due, 
the  rate  of  interest  paid,  etc.    Corresponding  to  each  of 
these  books,  is  of  course  an  account  in  the  ledger  which 
simply  gives  in  summary  form  the  totals  of  the  opera- 
tions recorded    in    the    bills    payable  or   bills  receivable 
books.    But  it  should  be  understood  that  these  books  are 
really  kept  in  lieu  of  ledger  accounts  and  represent  such 
ledger  accounts.    Beside  books  of  this  sort,  there  may  be 
various  other  books  growing  out  of  the  necessities  of  the 
business,  but  they  are  all  either  ancillary  to,  or  parts  of, 
the  original  books.    Thus,  for  example,  there  may  be  an 
"invoice"  book  into  which  are  pasted  invoices,  etc.   This 
then  is  really  a  way  of  filing  or  recording.    Other  books 

B— VIII— 3 


34  HENRY  PARKER  WILLIS 

that  may  be  kept  are  books  designed  to  record  returns  of 
goods  or  goods  returned  by  the  firm  to  others,  petty  cash 
book,  which  is  really  ancillary  to  the  cash  book  itself,  etc. 

Relation  between  Books. 

As  has  been  seen,  the  process  of  ''keeping"  the  books 
is  a  process  of  recording  transactions  originally,  and  then 
of  passing  them  through  the  various  forms  of  records  un- 
til the  whole  set  of  records  is  complete  and  satisfactory. 
What  does  this  process  of  keeping  the  books  imply?  In 
the  first  place,  it  of  course  means  that  every  transaction 
involving  the  transference  of  values  must  be  re- 
corded. Secondly,  it  means  that  every  transaction  thus 
recorded  must  be  put  through  identically  the  same  process 
of  analysis,  transfer,  and  ultimate  record  as  ever}^  other. 
It  is  only  in  that  way  that  the  books  can  be  made  to  show 
the  results  of  the  business  with  accuracy,  and  of  course 
under  the  system  of  ''double  entry"  earlier  described,  it 
is  only  in  that  way  and  on  those  conditions  that  the  books 
can  be  made  to  "balance"  and  thereby  give  prima  facie 
evidence  of  the  fact  that  they  have  been  correctly  kept. 
The  keeping  of  the  books  thus  necessitates  a  recognition 
of  thejr  relation  to  one  another  and  of  the  ways  in  which 
transactions  must  be  recorded  in  order  to  maintain  the 
same  relationship  between  them  that  was  established  at 
the  outset.  Every  transaction  must  figure  in  the  same 
way  and  to  the  same  extent  in  all  the  books  through 
which  it  is  passed,  or  in  other  words  the  change  in  trans- 
actions that  is  brought  about  in  passing  them  through  the 
various  books  is  merely  a  change  in  method  or  analysis 
and  not  a  change  in  substance.  -  We  have  already  referred 
incidentally  to  a  few  of  the  technical  terms  used  in  con- 
nection with  the  keeping  of  the  1)ooks  but  it  is  wDrth 
while  to  speak  of  these' once  more  at  this  point,  and  to  add 
one  or  two  ideas  not  thus  far  referred  to.  The  books  are 
said  to   be  *' opened"  when   the  "opening  entries"  have 


THE  PRINCIPLES  OF  ACCOUNTING  35 

been  made,  that  is  to  say  when  the  facts  about  the  organ- 
ization of  the  business  have  been  properly  recorded  in 
each  of  the  books  and  the  concern  is  ready  to  begin  oper- 
ations. Or  the  books  may  be  said  to  be  technically  opened 
when  they  are  simply  provided,  furnished  with  the  proper 
rulings  and  when  the  names  of  the  accounts,  etc.,  that  will 
certainly  be  needed  have  been  set  down.  As  seen  at  an 
earlier  point,  ''journalizing"  is  the  transferring  of  the 
items  recorded  in  the  day  book  to  the  journal  and  the  plac- 
ing of  them  in  journal  form,  while  ''posting"  is  the  name 
given  to  the  process  of  transferring  the  items  to  the 
ledger,  arranging  them  there  in  their  proper  shape  and 
under  suitable  headings.  In  general,  the  term  "posting" 
is  applied  to  the  keeping  of  any  book  up  to  date  with  all 
the  transactions  recorded  in  it  that  properly  belong  there, 
although,  technically  speaking,  the  word  is  used  specifi- 
cally of  the  ledger. 

Balancing  and  Closing. 

Two  terms,  however,  both  of  great  importance,  have 
not  yet  been  taken  account  of.  These  are  "balancing" 
and  "closing."  The  two  need  to  be  studied  in  close  con- 
nection with  one  another  both  with  reference  to  their  defi- 
nition and  to  the  processes  to  which  they  relate.  By  bal- 
ancing is  meant  the  bringing  of  the  various  accounts  to  a 
balance — that  is  to  say,  the  ascertainment  of  the  amounts 
that  are  required,  whether  on  the  debtor  or  creditor  side, 
to  be  entered  in  order  to  make  the  two  sides  foot  up  the 
same  amounts.  An  account  is  said  to  be  balanced  when 
the  additions  of  both  sides  have  been  made,  the  difference 
between  them  taken,  and  this  sum  written  on  one  side  or 
the  other — reading  when  on  the  debtor  side  "To  balance 

$     "    and    on    the     creditor    side    "By    balance 

$     . "    The  balancing  of  any  given  account  is  thus 

a  comparatively  simple,   almost  mechanical,   operation.* 

*  See  illustrative  accounts  at  the  end  of  Section  II,  p.  23,  where  the  simple 
transactions  there  presented  are  balanced. 


36  HENRY  PARKER  WILLIS 

But  the  balancing  of  the  books  as  a  whole  is  more  difficult 
both  theoretically  and  practically.  As  has  been  seen,  the 
day  book  is  merely  a  record  of  transactions  and  the  sum 
total  of  its  columns  is  nothing  more  than  the  sum  total 
of  all  operations  performed  or  of  all  operations  belonging 
to  the  particular  class  or  group  of  operations  to  which  a 
section  of  the  day  book  is  devoted.  When  we  come  to  the 
journal  or  ledger  the  case  is  different.  As  was  seen  in 
the  discussion  of  the  journal,  transactions  are  there  ar- 
ranged in  double  columns  with  a  view  to  making  them 
ready  for  the  ledger.  These  debtor  and  creditor  columns 
in  the  journal  should  therefore  total  the  same,  inasmuch 
as  under  the  theory  of  double  entry  every  debtor  entry  is 
offset  by  a  creditor  entry  somewhere.  In  the  journal, 
every  debtor  entry  is  immediately  offset  by  a  creditor  en- 
try or  series  of  entries  recorded  close  at  hand  in  the  par- 
allel column.  The  balancing  of  the  journal,  therefore,  is 
effected  by  merely  totaling  the  columns  of  the  book  and 
ascertaining  that  the  debtor  total  equals  the  creditor  total. 
In  the  same  way,  it  should  be  true  that  in  the  ledger  the 
total  of  all  debit  items  should  be  the  same  as  the  total  of 
all  credit  items.  This  would  mean  necessarily  that  the 
total  of  all  debtor  balances  in  the  accounts  should  equal 
the  total  of  all  creditor  balances  in  the  accounts.  The  first 
step  in  balancing  and  closing  the  books  is  usually  an  effort 
to  test  the  correctness  of  the  w^ork  by  drawing  off  what  is 
called  a  *' trial  balance."  This  is  done  by  writing  down  on 
a  sheet  of  paper  the  name  of  each  account  with  the  total 
of  its  debtor  postings  in  a  column  headed  Dr.  and  the  total 
of  its  creditor  postings  in  a  column  headed  Cr.  When  this 
has  been  done  for  every  account  in  the  ledger  and  the  sum 
total  has  been  added  the  two  columns  should  present  ex- 
actly the  same  total.  If  every  transaction  has  been 
passed  through  the  journal,  the  total  of  the  debtor  entries 
in  the  journal  should  be  the  same  as  the  total  debtor  en- 
tries in  the  trial  balance  while  the  total  creditor  entries 


THE  PRINCIPLES  OF  ACCOUNTINa  37 

in  the  journal  should  be  the  same  as  the  total  creditor 
entries  in  the  trial  balance,  the  two  being  of  course  equal 
to  one  another.  When  this  result  has  been  arrived  at,  the 
prima  facie  evidence  of  the  correctness  of  the  bookkeep- 
ing has  been  afforded.  It  is  then  possible  to  go  on  and 
complete  the  process  of  "closing."  This  may  be  defined 
as  simply  the  completion  of  the  accounting  process  by 
transferring  those  balances  which  show  results  of  the  bus- 
iness process  to  the  nominal  accounts  (profit  and  loss,  and 
capital)  to  which  they  are  related,  thereby  rendering  pos- 
sible an  idea  of  the  result  of  the  operations  for  the  fiscal 
period. 

Technique  of  Closing. 

But  how  is  this  "closing"  carried  out?  In  the  case  of 
the  retail  business  which  we  have  selected  as  the  basis 
of  our  reasoning,  the  process  of  closing  consists  of  two 
main  operations :  (1)  The  completion  of  profit  and  loss  ac- 
count, and  (2)  the  transfer  of  profit  and  loss  results  to  capi- 
tal account.  The  latter  step  is  taken  in  order  to  show  what 
addition  to  the  net  worth  of  the  business  or  what  sub- 
traction therefrom  has  been  brought  about  by  the  trans- 
actions of  the  fiscal  period.  The  process  of  completing 
the  profit  and  loss  account,  which  we  have  referred  to  as 
the  first  step,  involves,  however,  one  or  two  antecedent 
operations.  What  is  necessary  in  order  to  complete  the 
profit  and  loss  account?  If  there  had  been  accounts  like 
rent,  taxes,  insurance,  etc.,  in  which  the  entries  are  all  on 
one  side,  namely,  debtor  entries,  these  accounts  can  be  bal- 
anced only  by  "entering"  a  corresponding  creditor  entry 
in  the  opposing  column  merely  for  the  sake  of  formally 
"closing,"  and  then  "transferring"  the  balance  to  profit 
and  loss.  In  profit  and  loss  it  appears  on  the  debtor  side 
as  a  "loss,"  being  simply  entered  there  under  the  head  of 
the  account  from  which  it  is  drawn.  The  debtor  column 
of  profit  and  loss  is  thus  nothing  more  than  a  summary 


38  HENRY  PARKER  WILLIS 

of  the  debtor  totals  in  the  various  expense  accounts,  as 
rent,  taxes,  insurance,  etc.  If  the  business  is  simple  these 
entries  will  have  been  written  up  in  profit  and  loss  account 
direct  from  time  to  time  as  the  expenditures  have  been 
made.  But  if  the  items  have  been  numerous  so  that  they 
have  been  kept  under  separate  headings  in  the  way  just 
indicated,  they  appear  simply  as  subdivisions  of  profit 
and  loss  account  and  in  that  event  the  process  of  trans- 
ferring, of  which  we  have  spoken,  is  necessary.  If  this 
has  been  done  and  if  all  other  accounts  have  been  pre- 
viously balanced  as  indicated,  the  only  thing  that  remains 
uncertain  is  the  quantity  of  goods  or  property  remaining 
on  hand.  This  can  be  ascertained  only  by  directly  finding 
out  what  it  amounts  to — a  process  which  in  retail  business 
is  described  as  *' taking  an  inventory."  The  goods  ac- 
count when  originally  opened  of  course  carried  on  its 
debtor  side  the  total  amount  of  goods  that  had  been 
bought  by  the  business  and  for  which  therefore  the  ac- 
count itself  was  theoretically  ''debtor,"  or  indebted  to 
the  business.  If  less  than  the  total  amount  of  goods  has 
been  sold,  then  the  sales  items  (which  have  been  entered 
on  the  creditor  side)  will  be  less  than  the  total  amount  of 
goods.  By  ascertaining  the  original  cost  value  of  the 
goods  remaining  on  hand  and  entering  this  on  the  creditor 
side  along  with  the  sales,  the  two  sides  of  the  goods  ac- 
count will  deal  with  exactly  the  same  amount  of  goods. 
The  debtor  side  will  show  the  amount  of  goods  bought  at 
their  cost  value,  while  the  creditor  side  will  show  the 
amount  of  goods  sold  at  their  selling  value  plus  the  goods 
remaining  on  hand  at  their  cost  value.  The  creditor  side 
then  would  be  greater  in  its  total  than  the  debtor  side  by 
precisely  the  excess  amount  over  cost  that  has  been  realized 
on  those  goods  that  have  been  sold.  If  the  goods  have  been 
sold  for  less  than  cost,  the  debtor  side  would  be  greater 
than  the  creditor  side  and  this  would  mean  a  loss  to  the 
business  instead  of  a  gain.    It  should  be  added  that  in 


THE  PRINCIPLES  OF  ACCOUNTINa  39 

many  businesses  stocks  of  goods  kept  on  hand  deteriorate 
in  value,  and  that  in  taking  inventory  it  may  be  better 
to  represent  the  goods  at  their  cost  less  depreciation;  that 
is,  if  they  are  vegetables  and  some  have  rotted,  they  may 
be  represented  at  cost  minus  a  discount  representing  de- 
cline in  value.  It  may  conceivably  be  true  that  where 
this  is  done  the  loss  due  to  deterioration  of  goods  will  be 
so  great  as  to  offset  the  gain  due  to  the  sale  of  some  goods 
for  more  than  their  cost.  In  that  case  the  account  will 
show  a  loss.  But  at  this  point,  for  simplicity's  sake,  we 
will  not  contemplate  such  a  condition,  but  will  assume 
that  the  goods  are  of  a  kind  that  will  not  deteriorate  and 
that  they  may  therefore  be  represented  in  the  inventory 
at  their  exact  cost  value,  while  the  goods  that  have  been 
sold  are  assumed  to  have  been  sold  for  something  more 
than  cost.  In  that  case  the  balance  of  goods  account  is  on 
the  creditor  side  and  represents  a  gross  profit.  In  balanc- 
ing goods,  an  entry  to  balance  is  therefore  placed  on  the 
debtor  side  of  the  account  and  an  equal  entry  is 
transferred  to  the  creditor  side  of  profit  and  loss  be- 
cause it  represents  profits  derived  from  the  sale  of  goods 
which  constitute  what  profit  and  loss  account  *  Ogives"  in 
the  technical  sense,  and  out  of  which  this  account  has  to 
pay  the  debtor  items  which  it  has  ^'received"  in  the  tech- 
nical sense,  such  as  rent,  taxes,  wages,  etc.,  etc.  What  is 
the  next  step  in  the  process?  Profit  and  loss  account  is 
now  merely  a  summation  of  the  amounts  that  have  been 
paid  out  without  getting  any  tangible  return,  that  is,  that 
constitute  expense,  and  of  the  items  that  represent  receipts 
over  and  above  what  represents  actual  cost  of  goods.  If 
there  were  any  other  items  of  income  or  expenditure,  they 
would  have  to  be  similarly  recorded  in  profit  and  loss. 
For  example,  if  the  business  sold  services  of  some  kind — 
as  in  the  case  of  a  firm  of  lawyers — the  balance  of  the  ac- 
counts representing  services  would  have  to  be  transferred 
to  profit  and  loss  just  as  was  done  in  the  case  of  goods. 


40  HENRY  PARKER  WILLIS 

Supposing,  however,  that  profit  and  loss  has  been  made  a 
complete  summary  of  the  transactions,  this  must  mean 
that  the  difference  between  its  two  sides  is  the  net  profit 
of  the  concern;  that  is,  the  gross  profit  minus  the  ex- 
penses, and  is  therefore  a  net  addition  to  the  wealth  or 
property  or  capital  of  the  proprietor.  In  order  to  show 
the  results,  then,  this  balance  of  profit  and  loss  account 
(which  if  the  business  is  a  profitable  one  is  found  on  the 
debtor  side,  the  creditor  side  being  the  larger,  so  that  the 
debtor  balance  is  a  profit)  is  transferred  to  capital  ac- 
count and  is  there  placed  upon  the  creditor  side,  being 
therefore  added  to  the  original  entry  which  was  made  at 
the  beginning  of  the  business  period.  This  gives  a  total 
of  net  worth.  If  money  is  taken  out  of  the  business  by 
way  of  dividends  or  profits,  that,  of  course,  has  already 
been  done,  and  a  proper  showing  has  been  made  in  profit 
and  loss  under  the  head  of  debtor  entries  or  expenses. 
The  amount  that  is  carried  to  capital  account  as  a  net 
profit  at  the  last  is,  therefore,  an  actual  net  addition  to 
capital  and  is  so  represented.  It  is  now  possible  to  bal- 
ance the  capital  account  in  the  formal  way  by  simply  mak- 
ing a  balancing  entry  on  the  debtor  side,  which  represents 
the  total  amount  of  capital  continued  in  the  business,  and 
this,  therefore,  constitutes  the  capital  to  be  used  for  the 
next  fiscal  period  and  which  is  the  first  or  opening  creditor 
entry  for  the  next  fiscal  period. 

Balance  Sheet. 

When  the  books  have  thus  been  closed,  it  is  desirable 
to  make  out  what  is  called  a  *' balance  sheet,"  in  order  to 
state  the  condition  of  the  business  in  such  a  way  as  to  in- 
dicate to  the  business  man  himself  or  to  the  person  whom 
he  desires  to  inform,  what  the  precise  position  of  the  busi- 
ness is.  The  question  may  be  asked  whether  this  object 
has  not  already  been  obtained  in  closing  the  books,  since 
that  process  has  resulted  in  showing  the  net  capital  of  the 


THE  PRINCIPLES  OP  ACCOUNTING  41 

business.  The  answer  is  tliat  tlie  closing  process,  result- 
ing in  writing  up  and  closing  the  capital  account,  does  not 
sufficiently  show  the  results,  for  the  reason  that  it  does 
not  indicate  the  form  that  the  assets  and  liabilities  of  the 
concern  have  assumed.  For  instance,  if  the  business 
started  off  on  an  actual  cash  basis,  its  capital  was  all  in 
the  foiTii  of  cash,  but  at  the  end  of  a  business  period  such 
as  a  year,  it  may  be,  and  probably  is,  in  a  very  different 
form.  It  is  now  likely  to  consist  in  part  of  cash,  in  part  of 
trade  accounts  and  in  part  of  unsold  goods.  Against  these 
there  are  probably  claims  payable  by  the  concern  for  goods 
or  services  or  other  items  of  liability.  The  balance  sheet  is  a 
comparative  showing  of  such  assets  and  liabilities.  On 
the  liabilities  side,  are  set  down  the  amounts  that  the 
business  owes  and  on  the  assets  side  the  amounts  that  it 
possesses  or  that  are  due  it.  It  is  customary  to  say  that 
the  credit  balances  in  the  ledger  constitute  the  liabilities, 
while  the  debtor  or  debit  balances  of  the  ledger  are 
assets  and  that  by  taking  the  debtor  balances  and  adding 
them,  the  showing  of  assets  is  made,  while,  by  taking  the 
credit  balances,  adding  them  and  combining  with  capital, 
the  showing  of  liabilities  is  made.  The  difference  between 
the  sum  of  the  debtor  balances  and  the  sum  of  the  creditor 
balances  should  be  equal  to  the  total  capital  as  found  in 
closing  capital  account  and  this  should  afford  a  final  check 
of  the  accuracy  of  the  bookkeeping  operations.  Why  this 
is,  is  easily  understood  when  it  is  remembered  that  capital 
account,  as  closed,  is  simpl}^  the  original  credit  entry  in 
capital  augmented  by  the  net  balance  called  profit  which 
has  been  obtained  by  closing  up  goods  account,  transfer- 
ring it  to  profit  and  loss  and  there  offsetting  it  against  the 
expense  items  on  the  debtor  side  of  profit  and  loss.  The 
balance  sheet,  which  is  thus  the  combined  showing  of  the 
business,  would  in  any  except  a  very  simple  business,  be 
long  and  unwieldy  and  would  thereby  defeat  its  own  pur- 
pose, which  is  to  supply  a  bird's-eye  view  of  the  situation, 


42  HENRY  PARKER  WILLIS 

if  every  item  were  named  in  the  way  that  has  been  indi- 
cated.    In    the    ordinary    trial    balance,  therefore,  for  a 
business  of  any  considerable  size  there  is  usually  found 
simply  a  summary  of  classes  of  accounts.     Thus  on  the 
assets  side  may  be  found   such   groupings   as  ''Due  from 
sundry  debtors  or  customers,"  "Cash    on   hand    and    in 
bank,"  etc.,  while  on  the  liabilities  side  may  be  found  such 
groupings    as  "Due    sundry    trade    creditors,"  "Due  on 
short-time  loans,"  etc.,  "Capital,"  and  the  like.    Thus  the 
particular  items  that  go  to  make  up  the  assets  and  liabil- 
ities are  not  enumerated  but  are  simply  arranged  by  great 
groups.    In  this  way,  there  is  presented  to  the  proprietor 
or  to  the  outsider  who  is  to  be  informed,  a  clear-cut  view 
of  the  position  of  the  business.     The  only  thing  that  he 
now  lacks  in  order  to  form  a  definite  idea  of  the  situation 
is  a  knowledge  whether  the  assets  of  the  concern  are  worth 
what  they  are  represented  to  be.    For  example,  the  con- 
cern may  not  have  deducted  from  its  statement  of  goods 
on  hand  the  discount  which  must  unquestionably  be  al- 
lowed for  in  view  of  deterioration.    This  would  mean  that 
the  capital  account  was  vitiated  to  some  extent  because  it 
was  made  to  show  a  larger  amount  of  net  worth,  partly 
consisting  of  goods,  than  could  be  realized.    So,  also,  some 
of  the  assets  consisting  of  debts  due  the  concern  from  cus- 
tomers may  be  worthless  or  uncollectible  and  yet  may  be 
carried  on  the  books  at  their  full  face  value.    These  are 
points  on  which  the  accounting  system   affords   no   light 
and  about  which  knowledge  can  be  obtained  only  through 
an  intimate  examination  of  the  assets  themselves,  with  a 
view  to  ascertaining  whether  there  are  elements  of  deter- 
ioration or  loss  which  have  not  been  made  obvious  in  the 
accounting  system  as  carried  on.    If  there  are,  the  mean- 
ing is  that  the  accounting  system  has  not  been  sufficiently 
fully  organized  and  that  the  books  therefore  do  not  tell 
everything  that  they  should  tell  about  the  business. 


THE  PRINCIPLES  OF  ACCOUNTINa  43 

IV.    CAPITAL. 

Thus  far  we  have  spoken  first  of  the  constnietion  of 
an  accounting  system,  and  then  of  the  keeping  of  certain 
books  designed  to  record  the  facts  or  data  which  are  fitted 
into  this  system,  in  such  simple  terms  as  were  necessary  in 
order  to  convey  the  bare  outline  theory  of  the  subject. 
This  was  necessary  in  order  to  establish  a  basis  for  the 
further  discussion  of  the  theory  of  accounting  in  more 
general  and  technical  terms.  It  is  now  time  to  take  up  in 
greater  detail,  and  with  a  more  analytical  method,  the 
broader  questions  surrounding  the  various  accounts  and  to 
show  how  these  must  be  dealt  with. 

The  Capital  Account. 

In  speaking  of  the  simple  transactions  which  were  as- 
sumed for  purposes  of  illustration  in  our  earlier  discus- 
sion, it  was  noted  that  the  fundamental  problem  which 
the  merchant  always  has  in  mind  is  whether  or  not  his 
capital  has  been  increased  or  diminished.  In  speaking  of 
bookkeeping  we  showed  that  the  capital  account  is  theo- 
retically the  first  to  be  opened  and  the  last  to  be  closed. 
In  making  a  more  elaborate  analysis  of  the  question  of  cap- 
ital, it  is  therefore  worth  while  to  bear  these  facts  in 
mind,  remembering  that  it  is  around  the  capital  accounts 
that  the  accounting  and  bookkeeping  process  revolves. 
Capital  account  when  analytically  discussed,  however,  im- 
plies considerations  affecting  a  number  of  others.  But  in 
the  first  place  it  is  necessary  to  take  up  the  simple  as- 
sumptions upon  which  we  based  our  earlier  discussion  and 
to  see  how  far  they  must  be  modified  in  order  to  apply 
them  in  practice. 

How  Capital  Is  Contributed. 

The  first  assumption  thus  far  made,  and  the  one  which 
naturally  suggests  itself,  is  that  capital  is  put  into  a  busi- 


44  HENEY  PARKER  WILLIS 

ness  by  some  individual  who  designs  to  use  it  in  the  con- 
duct of  that  business.  This,  however,  is  not  necessarily 
the  case.  Today  the  rapid  rise  of  the  corporate  method  of 
doing  business  has  brought  it  about  that  a  considerable 
number  of  businesses,  perhaps  a  majority,  are  organized 
as  corporations.  Recent  investigations  by  the  Federal 
Government  have  shown  that  there  are  400,000  such  cor- 
porations organized  in  the  United  States  today.  A  cor- 
poration consists  of  individuals,  to  at  least  a  specified 
number  named  in  the  law  governing  incorporation,  who 
thereby  become  participants  in  the  affairs  of  the  concern 
and  who  jointly  contribute  its  capital.  If  there  are  not 
very  many  such  persons  and  if  they  contemplate  the  re- 
tention of  the  active  control  in  their  own  hands,  they  may 
prefer  to  form  a  partnership.  But  whether  the  business 
is  organized  as  a  partnership  under  the  laws  of  the  state 
in  which  it  is  created  or  as  a  corporation  under  the  law 
of  incorporation  in  that  state,  the  point  just  noted  is  the 
same,  as  the  capital  is  contributed  by  several  persons  who 
become  joint  contributors  and  joint  participants  in  the 
business.  In  any  of  these  cases  the  capital  account  is  the 
same  in  its  essential  nature,  but  where  there  is  more  than 
one  person  involved  there  arises  an  additional  problem  of 
keeping  track  of  the  different  relations  to  the  business 
which  are  occupied  by  the  various  persons  who  partic- 
ipate in  such  ownership.  Fundamentally,  capital  account 
remains  unchanged  in  its  essential  nature.  If  John  Smith 
is  alone  in  the  business  his  capital  account  bears  the  title : 

John  Smith,  Capital  Account. 

If  John  Smith  and  Richard  Brown  are  jointly  engaged 
the  capital  account  is  entitled: 

Smith  &  Brown,  Capital  Account. 

If  they  are  incorporated  along  with  a  number  of  others 
the  title  may  be: 

The  Smith  &  Brown  Co.,  Capital  Account. 


THE  PRINCIPLES  OF  ACCOUNTING  45 

Taking  up  first  the  case  where  two  or  more  persons  are 
united  as  partners,  it  is  clear  that  their  relations  to  the 
business  may  be  sufficiently  indicated  by  subdividing  the 
capital  account  into  as  many  separate  sections  or  divisions 
as  there  are  partners.  Thus  under  the  heading  "Smith  & 
Brown,  Capital  Account"  there  might  be  a  sub-heading 
"John  Smith"  under  which  would  be  entered  the  amount 
of  capital  contributed  by  Smith  at  the  start  and  another 
sub-heading  "Richard  Brown"  in  which  would  be  entered 
as  a  credit  the  amount  of  capital  originally  contributed  by 
Richard  Brown.  Then,  when  the  profits  are  to  be  carried 
to  capital  account  from  profit  and  loss,  they  will  be  appor- 
tioned between  Smith's  subdivision  and  that  of  Brown, 
according  to  the  terms  of  the  original  agreement.  If 
Smith  and  Bro^vn  are  equal  partners  and  are  to  share 
equally,  one-half  the  net  profits  will  be  credited  to  each. 
Or,  if  by  virtue  of  some  special  agreement  set  forth  in  the 
articles  of  partnership,  one  is  to  be  favored  above  another, 
the  entry  will  be  made  upon  the  proportionate  basis  which 
is  thus  indicated — as  two-thirds  to  one,  and  one-third  to 
the  other.  It  is  entirely  possible  that  the  individual  or 
partners  who  are  in  control  of  the  business  may  one  or  all 
desire  to  draw  some  cash  from  time  to  time.  If  John 
Smith,  for  example,  being  alone  in  the  business,  desired 
to  do  so,  the  proper  entry  would  be  a  debit  entry  on  the 
capital  account  which  would  amount  merely  to  a  state- 
ment that  he  had  reduced  his  capital  by  that  amount.  The 
same  thing  is  true  where  two  or  more  partners  are  en- 
gaged. By  simply  debiting  each  with  the  amount  he  draws, 
the  net  reduction  effected  in  his  capital  is  indicated  and 
the  corresponding  change  in  the  distribution  of  profits 
will  be  determined  either  by  reference  to  the  partnership 
agreement  or  by  reference  to  some  oral  or  other  under- 
standing. If  the  individual  or  individuals  who  are  con- 
ducting the  business  are  likely  to  draw  out  money  quite 
frequently  in  small  sums,  it  may  be  worth  while  in  order 


'46  HENRY  PARKER  WILLIS 

to  avoid  making  tlie  capital  account  long  and  complex  to 
open  what  is  called  a  *' drawing"  account.  This  account 
is  nothing  more  than  a  memorandum  carried  for  the  pur- 
pose of  keeping  track  of  numerous  debit  items  which 
would  other\sdse  appear  in  capital  account.  At  the  end  of 
the  year  or  other  fiscal  period,  the  total  of  these  debit  en- 
tries in  drawing  account  is  transferred  to  the  debit  side 
of  that  section  of  capital  account  which  belongs  to  the 
particular  partner  whose  transactions  are  recorded.  After 
the  books  have  been  fully  written  up,  the  sum  total  of  the 
net  capital  shoAvn  in  each  of  the  partner's  subdivisions  in- 
dicates the  gross  capital  of  the  concern.  The  situation  is 
more  complicated  when  the  business  assumes  a  corporate 
form.  This  is  because  of  the  conditions  surrounding  the 
corporate  type  of  organization. 

Corporation  Capital  Accounts. 

Suppose  it  has  been  determined  to  organize  the  Smith 
&  Brown  Company,  a  corporation.  Articles  of  incorpor- 
ation are  prepared  and  the  concern  is  legally  incorporated. 
In  order  to  become  thus  legally  incorporated,  it  is  obliged 
to  fix  as  a  definite  sum  the  amount  of  its  capital  or  at  all 
events  to  name  the  maximum  amount  of  capital  it  designs 
to  employ.  Such  nominal  capital  is  described  as  the  ^^cap- 
italization" of  the  concern  and  may  or  may  not  be  fully 
paid  up.  It  is  at  all  events  the  named  valuation  of  what 
is  being  put  into  the  concern  by  those  who  start  it.  It  is 
customary  to  divide  this  capitalization  into  so-called 
** shares,"  each  of  which  indicates  a  distinct  fraction  of 
the  total  capitalization.  It  would  be  theoretically  possible 
to  have  shares  of  stock  issued  as  ^'one  one-hundredth 
part  of  the  Smith  &  Brown  Company"  or  one  one-thous- 
andth part,  but  in  practice,  under  existing  law,  it  is  cus- 
tomary to  assign  to  each  share  of  stock  a  nominal  face,  or 
par,  value  of  its  own.  The  figure  which  is  most  commonly 
used  as  the  par  value  of  a  share  of  stock  is  $100.    Suppose 


THE  PRINCIPLES  OF  ACCOUNTING  47 

that  Smitli  &  Brown  were  incorporated  for  $10,000  with 
shares  at  a  par  value  of  $100.  This  would  mean  that  in 
all  there  were  100  shares  outstanding,  each  of  the  nominal 
value  of  $100,  or,  in  other  words,  that  the  owner  of  each 
share  was  entitled  to  one-hundredth  part  of  the  value  of 
the  concern.  Now  suppose  that  Smith  &  Brown,  finding  it 
impossible  by  themselves  to  hold  the  total  of  the  stock  in 
their  own  possession,  decided  to  sell  twenty  shares  of  the 
par  value  of  $100  each — $2,000  in  all — ^to  other  persons, 
say  employes  of  the  company,  at  the  rate  of  one  share  to 
each.  This  will  at  once  raise  the  question  of  keeping  track 
of  the  accounts  of  the  different  shareholders  and  of  know- 
ing how  the  ownership  of  the  shares  changes,  since  laws 
providing  for  the  government  of  corporations  invariably 
furnish  a  means  for  the  sale  or  transfer  of  any  share  or 
shares  from  their  existing  owner  to  a  new  or  prospective 
o^^Tier.  Theoretically,  the  fact  that  the  concern  is  organ- 
ized as  a  corporation  would  not  necessarily  make  any  dif- 
ference with  the  accounting.  There  might  be  opened  in 
the  ledger  a  series  of  subdivisions  of  capital  account  each 
with  the  name  of  the  owner  of  the  share  as  a  descriptive 
heading  and  the  amount  of  the  par  value  of  the  share  held 
by  him  as  the  credit  entry  in  his  section  of  capital  account. 
Practically,  this  would  be  out  of  the  question  as  soon  as 
the  number  of  shareholders  became  considerable  and 
would  be  substantially  impossible  for  bookkeeping  reasons 
as  soon  as  the  shareholders  began  to  transfer  or  combine 
their  holdings.  For  this  reason,  additional  bookkeeping 
and  accounting  methods  are  resorted  to  as  soon  as  a  con- 
cern is  organized  in  a  corporate  form.  If  the  concern  does 
not  require  that  its  stock  shall  be  paid  up  by  the  persons 
who  subscribe  to  it  (that  is  put  in  the  capital)  at  the  out- 
set, they  being  allowed  to  pay  it  in  on  the  installment  plan, 
what  is  called  an  installment  book  must  be  kept.  This  is 
nothing  more  than  an  outline  record  of  the  names  of  the 
original  subscribers  and  the  amounts  they  have  paid  on  the 


48  HENRY  PARKER  WILLIS 

different  dates  set  for  the  payment  of  the  instalhnents.  In 
addition  to  this  there  is  opened  what  is  called  a  stock 
ledger.  The  stock  ledger  simply  includes  a  series  of  ac- 
counts with  individuals  who  have  subscribed  for  the  stock. 
When  they  have  fully  subscribed,  their  accounts  are  of 
course  complete.  They  then  show  on  the  creditor  side  the 
amount  paid  in,  and  on  the  debtor  side  the  number  of 
shares  assigned  to  or  subscribed  for  by  the  particular 
shareholder.  When  each  has  fully  paid  up  his  subscrip- 
tion, his  account  can  be  closed.  The  capital  account  in 
the  ledger  simply  represents  on  its  creditor  side,  as  before, 
the  sum  total  of  the  cash  contributed  by  the  various  stock- 
holders during  the  period  of  organization.  Some  account- 
ants think  it  desirable  also  to  open  an  additional  account 
in  the  ledger  entitled  ^'Stockholders  Account."  Such  an 
account  is  debited  with  the  total  of  the  shares  issued  be- 
cause the  stockholders  are  indebted  to  the  company  for 
that  amount.  Then  when  they  have  paid  in  their  cash  this 
is  credited  to  the  stockholders  account,  and  the  account  is 
closed,  being  thereafter  of  no  further  service.  Meanwhile, 
a  special  record  of  cash  has  usually  been  carried  during 
the  period  of  organization,  in  which  are  entered  on  the 
debit  side  the  amounts  of  cash  received  by  the  concern 
from  stockholders,  while  on  the  credit  side  are  entered  the 
amount  paid  out  for  expenses  and  any  amounts  that  may 
be  refunded  to  stockholders  who  want  to  get  out  of  the  en- 
terprise and  are  allowed  to  do  so  under  the  terms  of  or- 
ganization. But  at  the  close  of  the  organization  process, 
the  general  ledger  finds  itself  with  a  capital  stock  account 
in  which  is  entered  as  a  credit  item  the  sum  total  of  the 
contributions  by  all  of  the  stockholders  and  with  a  cash 
account  in  which  is  entered  as  a  debit  item  ''To  stockhold- 
ers" or  *'To  cash  capital"  the  actual  amount  of  cash  which 
has  been  received.  If  some  of  this  cash  has  been  disbursed 
in  the  meanwhile  for  organization  expenses,  it  will  neces- 
sitate the  opening  of  a  special  expense  account  in  which 


THE  PRINCIPLES  OP  ACCOUNTINa  49 

will  be  entered  as  a  debit  entry  the  organization  expenses 
of  various  kinds.    It  is  obvious  that  the  sum  total  of  the 
debit  entries  in  cash  and  in  expense  account  will  equal  the 
total  cash  capital  contributed   by   the    stockholders    and 
credited  to  the  capital  stock  account  as  a  lump  sum.    It  is 
clear  that  the  stockholders  will  want  some  actual  tangible 
evidence  of  their  ownership  in  the  concern.    This  is  af- 
forded by  establishing  a  *^ certificate  of  stock  book"  which 
consists  of  a  series  of  printed  or  engraved  certificates  at- 
tached to  stubs  similar  to  the  stubs  of  a  check  book.    The 
certificate  is  filled  in  with   the  name  of  the   stockholder 
and  the  number  of  shares  which  the  certificate  represents 
and  when  his  stock  is  paid  up  the  certificate  is  torn  off  and 
given  to  him.    On  the  stub  is  an  entry  of  his  name,  the 
date  at  which  issued,  the  serial  number  of  the  certificate 
and  the  number  of  shares  which  it  represents.     Suppose 
that  such  a  certificate  is  issued  to  John  Smith  for  30  shares 
in  the  new  concern.    Smith  may  decide  to  dispose  of  10 
shares.    In  that  case  he  will  return  the  certificate  and  ask 
to  have  two  new  ones  made  out,  one  for  20  and  the  other  for 
10  shares.    The  old  certificate  is  pasted  back  to  the  stub 
from  which  it  was  originally  torn  and  a  reference  is  made 
to  the  two  new  certificates  issued  in  place  thereof,  giving 
their  numbers.    Then  John   Smith   can  dispose  of  his  10 
shares,  assigning  the  certificate  by  signing  his  name  on  the 
back  in  a  form  provided  for  that  purpose.    The  new  owner, 
say  J.  P.  Morgan,  returns  the  certificate  to  the  concern  and 
it  is  pasted  back  on  the  stub  from  which  it  came,  while  a 
new  one  in  favor  of  J.  P.  Morgan  is  issued  in  lieu  thereof. 
Other  books  may  be  found   to  be   desirable  for  keeping 
track  of  the  various    changes    and    operations  connected 
with  the  issue,  retirement,  and  exchange  of  shares. 

Stock  Retained. 

It  does  not  necessarily  follow  that  the  Smith  &  Brown 
Company  will  decide  to  issue  all  of  its  shares  at  once.  SmitK 

B— VIII— 4 


50  HENRY  PARKER  WILLIS 

&  B^o^^^l  after  looking  the  ground  over  may  come  to  the 
conclusion  that  $10,000  is  a  larger  capitalization  than  they 
need  to  start  with  and  that  they  can  get  along  with  a  small- 
er amount  which  they  are  able  personally  to  contribute 
without  bringing  in  outsiders  by  selling  shares  to  them.  In 
that  case,  Smith  &  Brown  may  resolve  each  to  take  out  4d 
shares,  each  paying  $4,000  in  full  settlement  thereof  and 
not  to  issue  the  remaining  20  shares.  If  this  20  shares 
thus  retained  by  the  concern  is  held  by  the  concern  in  gen- 
eral ownership  for  a  possible  future  issue,  it  is  called 
^'treasury  stock."  It  can,  at  some  later  date,  be  issued, 
should  such  a  course  be  determined  on  as  advantageous. 
For  example,  if  two  years  after  starting.  Smith  &  Brown 
find  that  their  business  is  growing  and  needs  more  capital, 
they  may  determine  after  all  to  sell  out  the  $2,000  worth 
of  stock  to  outsiders.  The  situation  is  then  the  same  as  it 
would  have  been  had  this  stock  been  issued  at  the  begin- 
ning. What  has  happened  has  been  that  additional  capital 
is  put  into  the  business.  The  old  capital  account  is  closed 
and  a  new  start  is  made  with  the  enlarged  capital  which 
has  now  been  contributed  or  **put  in."  There  are  other 
ways  in  which  this  treasury  stock  may  be  issued,  but  they 
will  not  be  considered  at  this  point. 

Payment  for  Stock. 

As  stated  at  the  opening  of  this  section  several  as- 
sumptions were  made  at  the  outset  in  speaking  of  the  ques- 
tion of  capital.  One  of  them — the  question  of  ownership 
— has  now  been  disposed  of.  A  second  must  next  be 
dealt  with.  It  has  been  taken  for  granted  thus  far  that 
capital  is  paid  up  in  cash  to  start  with.  Such  is  by  no 
means  always  the  case.  In  most  businesses  where  the 
original  capital  is  contributed  in  the  form  of  money,  the 
money  itself  is  of  no  service  except  in  so  far  as  a  small  sum 
may  be  kept  on  hand  for  current  expenses.  The  money  is 
taken  by  the  managers  of  the  concern  and  is  invested  in 


THE  PRINCIPLES  OF  ACCOUNTINa  51 

something.  In  retail  trade  it  is  probably  largely  invested 
in  stocks  of  goods.  In  manufacturing  it  will  be  largely  in- 
vested in  the  factory  building,  the  machinery,  etc.,  neces- 
sary to  carry  on  the  operations,  but  in  every  case  the  object 
of  the  managers  will  be  to  invest  it  in  a  form  in  which  it  can 
be  used  for  earning  a  business  profit  by  buying  and  selling 
something.  The  question  may  be  asked:  Why  should  not 
the  persons  who  organized  the  business  contribute  the 
things  with  which  business  is  to  be  done  directly,  instead 
of  converting  them  into  money  and  then  having  the  money 
expended  for  buying  the  same  sort  of  things'?  Or  to  put 
the  point  in  another  way,  if  the  organizers  of  the  concern 
have  the  materials  for  business  already  available,  why 
should  they  not  be  allowed  to  put  them  into  the  business 
at  the  start  in  payment  for  their  stock?  There  is  no  reason 
why  this  should  not  be  done,  and  as  a  matter  of  fact  it  is 
done  in  probably  the  large  majority  of  instances.  The  only 
serious  question  that  arises  in  connection  with  such  a 
matter  is  that  of  valuation.  It  is  plain  that  the  persons 
who  are  organizing  a  concern  are  likely  to  be  given  special 
favor  in  the  purchase  of  their  property  which  would  not 
be  given  to  outsiders.  There  may  be  no  particular  harm 
in  this  if  all  of  those  who  go  in  are  treated  exactly  alike — 
that  is  to  say,  have  the  same  degree  of  favor  or  over-val- 
uation allowed  them.  Of  course,  if  some  stockholders  are 
required  to  contribute  money  while  others  are  allowed  to 
pay  in  property,  the  latter  being  valued  very  highly,  the 
operation  is  merely  a  shrewd  scheme  whereby  the  o-\vners 
of  the  property  sell  it  for  more  than  it  is  worth  while  the 
persons  who  contribute  the  money  pay  for  the  property 
at  too  high  a  valuation.  This,  however,  is  a  question  of 
business  prudence  and  policy  and  not  primarily  of  ac- 
counting. How  does  such  payment  in  property  affect  cap- 
ital account?  Let  us  suppose  that  Smith  Sc  Brown  in  or- 
ganizing the  Smith  So  "Brown  Company  determine  to  do  so 
upon  a  basis  on  which  Smith  contributes  a  store  supposed 


52  HENRY  PARKER  WILLIS 

to  be  wortli  $4,000  while  Bro^^^l  who  has  been  doing  busi- 
ness in  a  rented  building  puts  in  a  stock  of  goods  supposed 
to  be  worth  $4,000.    Here  we  have  the  Smith  &  Brown 
Company  organized  with  its  $8,000  of  capital  stock  out- 
standing, $4,000  in  the  hands  of  Smith  and  $4,000  in  the 
hands  of  Brown.    The  capital  account  shows  a  creditor  en- 
try of  $8,000.    No  cash,  however,  has  been  contributed  so 
that  it  is  not  necessary  to  open  the  cash  account  unless  by 
a  fiction  the  two  men  are  supposed  to  contribute  cash  to 
the  amount  of  their  stock  which  is  promptly  paid  out  to 
them  in  exchange  for  their  property  at  the  agreed-upon 
rate.    It  is,  however,  necessary  to  open  accounts  showing 
the  form  which  the  capital  has  taken.    One  of  these  will 
obviously  be  '* goods"  in  which  there  will  be  a  debit  entry 
of  $4,000  while  the  other  will  be  "real  estate"  in  which 
there  will  be  a  debit  entry  of  $4,000,  the  two  totaling  the 
same  as  the  nominal  contributions  of  Smith  &  Brown  to 
the  capital.    Suppose,  however,  that  Smith  &  Brown  rec- 
ognized that  the  items  of  property  they  had  put  in  were  not 
worth,  as  an  actual  matter  of  selling  value,  the  sums  at 
which   they   were   set  down  in  our  supposition,  although 
they  believed  that  they  might  be  justified  in  so  represent- 
ing them  because  of  the  fact  that  they  had  an  established 
trade  that  would  enable  them  to  pay  interest  or  dividends 
on  a  total  of  $8,000.    What  change  would  this  make  in  the 
accounting?    If  Smith  &  Bro^oi  were  determined,  as  we 
have  assumed,  to  keep  this  stock  outstanding,  it  would  be 
necessary,  if  they  were  to  have  a  true  valuation  of  assets 
at  less  than  the  face  of  the  stock,  that  there  should  be 
opened  at  the  start  some  other  account  which  would  ac- 
count for  or  represent  the  difference  between  the  nominal 
value  of  the  shares  issued  and  the  actual  value  of  the  assets 
put  in.    For  example,  if  we  assume  that  the  building  con- 
tributed by  Smith  is  really  worth  $3,000,  while  the  stock 
contributed  by  Brown  is  also  worth  only  $3,000,  while  the 
shares  issued  are  still  $8,000,  then  we  have  a  situation  in 


THE  PRINCIPLES  OF  ACCOUNTING  53 

wliicli  capital  stock  account  shows  a  credit  entry  of  $8,000, 
while  real  estate  shows  a  debit  entry  of  $3,000  and 
goods  account  a  debit  entry  of  $3,000.  Another  debit 
entry  of  $2,000  must  be  provided  somewhere  not  merely 
from  the  standpoint  of  practical  bookkeeping  in  order  that 
the  books  in  which  these  accounts  are  recorded  may  *' bal- 
ance," but  also  in  order  that  the  student  of  these  accounts 
may  know  exactly  what  was  the  nature  of  the  value  or 
assets  on  the  strength  of  which  the  capital  stock  was 
issued.  It  is  necessary,  then,  to  raise  another  account  to 
carry  this  $2,000.  Almost  any  appropriate  heading  may  be 
employed  for  this  account.  One  frequently  employed  is 
that  of  ''good  will."  By  opening  a  "good  will  account"  with 
a  debit  entry  of  $2,000  it  is  made  to  appear  that,  of  the 
capital  stock  issued  by  Smith  &  Brown,  incorporated, 
$3,000  is  real  estate,  $3,000  actual  value  of  goods,  while 
$2,000  is  represented  merely  by  experience,  prestige,  or 
business  acquaintance — in  other  words,  "good  will." 
Some  concerns,  where  the  process  of  putting  the  shares  on 
the  market  has  been  long  and  expensive,  carry  an  account 
called  "organization  expenses."  In  this  may  be  put  as 
debit  entries  any  discounts  that  may  have  been  allowed 
to  stockholders  in  order  to  induce  them  to  come  in  as  well 
as  commissions  paid  to  persons  who  have  assisted  in  put- 
ting the  stock  on  the  market.  On  the  other  hand,  the  stock 
may  be  issued  at  a  premium.  Suppose  for  example  that 
Smith  &  Brown  considered  the  assets  they  had  contributed 
as  worth  more  than  the  par  value  of  the  stock  outstanding, 
they  would  still  have  a  capital  account  which  would  show 
the  par  value  of  the  stock  outstanding.  The  real  estate 
and  goods  account  would  show  debit  entries  of  (say)  $4,500 
respectively.  It  would  be  necessary  then  to  open  some  ac- 
count to  show  what  disposition  has  been  made  of  the  excess 
of  real  assets  over  capital.  This  might  be  done  by  opening 
an  account  entitled  "reserve"  or  "surplus"  with  a  credit 
entry  of  $1,000.    This  credit  entry  would  be  composed  of 


64  HENRY  PARKER  WILLIS 

(in  our  illustration)  two  items  "By  real  estate $500'' 

and  "By  goods  . . .  .$500,"  because  $500  was  the  excess  of 
the  value  of  the  real  estate  contributed  by  Smith  over  and 
above  the  stock  issued  to  him,  while  $500  is  also  the  excess 
of  the  value  of  the  goods  contributed  by  Brown  issued  by 
him.  If  the  stock  had  been  issued  for  cash  the  credit  entry 
in  reserv^e  account  would  be  "By  cash $1,000." 

Payment  for  Bonds. 

Although  the  capitalization  of  a  concern  is  usually 
spoken  of  as  if  it  applied  only  to  the  stock  issued,  and  al- 
though a  great  many  people  are  in  the  habit  of  thinking 
of  bonds  as  if  they  represented  a  loan  made  by  a  company 
for  the  purpose  of  making  up  deficits  or  losses  or  for  the 
purpose  of  paying  in  part  for  property  purchased  which 
the  concern  was  unable  to  liquidate  in  cash,  such  is  by  no 
means  usually  the  case.  On  the  contrary,  bonds  are  fre- 
quently issued  at  the  outset  of  the  business  as  a  means  of 
representing  a  part  of  the  capitalization  of  the  concern. 
In  that  event  there  is  no  reason  why  the  accounting  for  the 
bonds  should  not  be  carried  on  as  a  phase  of  the  capital  ac- 
count. A  "bond  account"  is  opened  and  is  conducted  in 
precisely  the  same  way  as  capital  account.  The  total  bonds 
issued  have  yielded  a  certain  amount  of  cash.  The  first 
entry  in  bond  account  then  is  on  the  credit  side  just  as  in 
the  case  of  capital  and  is  "By  cash. . .  .$  ."  If  the  bonds 
are  issued  at  a  discount  or  at  a  premium,  the  method  of 
dealing  with  them  is  the  same  as  that  which  was  followed 
in  dealing  with  capital  stock  under  similar  conditions. 

Y.    CASH  ACCOUNT. 

Theory  of  Cash. 

In  our  early  simple  illustrations,  it  was  assumed  that 
actual  cash  was  received  and  paid  for  every  item  bought 
and  every  item  sold.    Thus,  when  an  individual  went  into 


THE  PRINCIPLES  OF  ACCOUNTINa  55 

business  lie  was  supposed  to  put  in  cash  as  representing 
his  capital.  This  gave  rise  at  once  to  a  debit  entry  in  cash 
account  corresponding  to  the  credit  entry  in  capital  ac- 
count and  signifying  that  the  stock  of  cash  held  by  the  con- 
cern was  simply  the  amount  of  cash  that  had  been  put  in 
as  capital.  That  is  to  say,  the  concern  at  starting  had  a 
certain  amount  of  cash  which  constituted  its  assets  and 
owed  an  equal  amount  to  the  proprietor  for  the  capital 
which  he  had  invested.  Later  we  saw  that  the  capital  is  not 
necessarily  represented  by  cash  at  all,  although  for  the  sake 
of  convenience  it  may  be  assumed  that  the  property  is  put 
in  in  the  form  of  cash  and  that  this  cash  is  as  promptly  dis- 
bursed at  a  specified  rate  to  the  members  of  the  concern 
in  return  for  various  tangible  assets  which  it  has  been 
agreed  they  shall  put  in  at  a  determined  valuation.  How- 
ever this  may  be  arranged,  every  concern  starts  with  some 
cash,  since  that  is  necessary  to  pay  running  expenses,  so 
that  as  a  matter  of  fact  the  first  entry  in  cash  account  in 
the  ledger  is  invariably  on  the  debtor  side  where  it  indi- 
cates that  a  portion  of  the  capital  has  taken  the  form  of, 
or  has  been  contributed  in,  actual  cash.  This  is  strictly 
true,  however,  only  in  those  cases  where  the  concern  has 
the  cash  physically  on  hand  in  its  safe  or  cash  drawer.  It 
should  be  understood,  however,  that  the  amount  of  cash 
which  is  carried  in  this  way  in  modem  businesses  is  not 
large.  Theoretically,  a  concern  might  insist  on  being  paid 
in  cash  for  everything  it  sold  or  did,  and  might  stand  ready 
to  pay  cash  for  everything  it  bought  or  had  done  for  it.  It 
might  go  so  far  as  to  demand  the  actual  transfer  of  money 
in  each  case.    But  ordinarily  it  does  not  do  this. 

Modern  Means  of  Payment. 

In  lieu  of  cash  payments,  it  is  much  more  customary  to 
pay  or  be  paid  in  a  check  or  draft  on  a  bank  or  in  commer- 
cial paper.  The  use  of  these  means  of  payment  in  lieu  of 
cash  makes  it  necessary  to  establish  other  methods  of  ac- 


56  HENRY  PARKER  WILLIS 

counting  corresponding  thereto.  These  other  accounts, 
however,  have  a  very  close  and  intimate  relationship  to 
cash,  inasmuch  as  ultimate  convertibility  into  cash  is  the 
test  of  the  goodness  of  every  check,  draft,  or  piece  of  com- 
mercial paper  that  passes  between  business  men.  It  is 
necessary,  therefore,  to  consider  the  methods  of  accounting 
applicable  to  these  other  means  of  payment  not  only  in 
their  relation  to  the  business  itself  but  also  in  their  relation 
to  cash  account  for  the  reason  just  stated.  The  other 
methods  of  payment  may  now  be  considered. 

The  Bank  and  the  Check. 

In  modern  business  every  man  who  carries  on  transac- 
tions of  any  considerable  size,  and  even  those  whose 
transactions  are  small  but  who  want  to  have  an  accurate 
record  of  everything  thej^  pay,  deal  through  banks.  The  re- 
lation of  the  bank  to  the  business  man  has  several  aspects, 
but  at  this  point  we  will  consider  merely  its  aspect  as  a 
keeper  of  actual  money.  For  example.  Smith  &  Brown 
when  they  started  business  may  be  assumed  to  have  put  in 
their  capital  in  the  form  of  actual  gold  coin  to  the  extent 
of  $8,000.  Not  wishing  to  keep  this  amount  in  the  safe, 
they  decide  to  deposit  it  in  a  bank  which  they  have  selected 
for  the  purpose.  The  entry  in  the  cash  account  as  has  been 
seen  is  on  the  debtor  side  and  is  (Smith  &  Brown  being 

organized    as   a   corporation)    ''To   capital $8,000." 

When  this  cash  is  placed  in  the  bank  (the  First  National 
having  been  selected)  the  cash  account  will  stand  as  fol- 
lows : 

CASH. 

Dr.  Cr. 


Jan.  1    To  capital 


$8,000 


Jan.  1    By  1st  Nat'l  Bank  $8,000 


This  simply  shows  that  $8,000  was  paid  in  in  cash  as  a 
result  of  the  contributions  of  capital  and  was  promptly 
paid  out  again  in  the  form  of  a  deposit  in  the  First  National 
Bank.    Of  course  a  bank  account  with  the  First  National 


THE  PRINCIPLES  OF  ACCOUNTINa  57 

should  likewise  be  opened  and  that  would  stand  as  follows; 

FIRST  NATIONAL  BANK. 
Dr.  Cr. 

Jan.  lITo  cash  deposit  |$8,000    11  I  I 

Suppose  that  Smith  and  Brown,  instead  of  paying  in 
their  contributions  of  capital  in  the  form  of  coin,  have  sim- 
ply turned  them  in  in  the  form  of  checks.  After  endorsing 
these  checks  in  the  firm's  name,  the  bookkeeper  or  cashier 
of  the  concern  might  take  them  direct  to  the  bank  and  de- 
posit them,  in  which  case  the  account  of  the  First  National 
Bank  would  stand  exactly  as  above.  There  would  then  be 
no  absolute  necessity  for  passing  the  items  through  cash 
account.  Theoretically,  since  they  are  equivalent  to  cash 
and  could  be  changed  into  cash  at  the  banks  on  which  they 
are  drawn,  they  might  be  treated  simply  as  gold  coin  and 
entered  on  the  debtor  side  of  cash  account  just  as  in  the 
illustration  already  given,  then  re-entered  on  the  creditor 
side  when  deposited,  a  corresponding  debtor  entry  being 
made  in  the  First  National  Bank  account  as  soon  as  the  de- 
posit had  been  effected.  This  would  merely  mean  that 
there  had  been  a  compensating  entry  on  each  side  of  cash 
account  which  was  thereby  relieved  of  further  responsi- 
bility for  the  $8,000,  such  responsibility  being  transferred 
to  the  bank.  A  method  which  might  be  followed  by  some 
concerns  would  be  to  omit  bank  account  entirely  and  treat 
all  checks  received  as  actual  cash  items.  In  such  a  case 
it  would  be  left  to  the  bank  to  keep  track  of  the  deposits 
made  with  it,  whether  in  the  form  of  cash  or  checks,  and  to 
record  them  in  the  pass  book  of  the  concern.  That  is  to  say, 
the  concern  would  simply  conduct  its  cash  account  on  the 
original  basis,  regarding  checks  received  and  checks  given 
by  it  as  cash,  and  simply  treating  its  deposit  in  the  bank  as 
a  fund  placed  there  for  safekeeping.  Proper  accounting, 
however,  calls  for  a  segregation  of  cash  and  bank  items. 
What  has  been  said  about  sums  that  are  received  in  the 


58  HENRY  PARKER  WILLIS 

form  of  checks  and  are  redeposited  in  banks  applies  in  like 
measure  to  sums  that  have  been  paid  out  in  the  form  of 
checks  drawn  by  the  concern  on  its  own  bank.  As  just 
seen,  it  would  be  possible  to  regard  all  such  payments  as 
payments  of  cash  to  be  offset  by  drawing  money  out  of  the 
bank  and  debiting  it  to  the  cash  account.  In  practice,  the 
preferable  way  would  be  to  pass  through  the  cash  account 
only  those  items  that  were  actually  received  in  the  form  of 
cash  and  redeposited,  or  were  drawn  out  of  the  bank  in  the 
form  of  cash  to  meet  payments  over  the  counter  and  were 
then  disbursed  in  that  way,  while  receipts  of  checks  di- 
rectly deposited  in  the  bank  should  be  entered  direct  as 
debtor  items  in  bank  account  and  payments  made  by 
check  should  be  entered  as  creditor  items  in  bank  account. 
The  firm's  pass  book  at  the  bank  then  serves  as  a  means  of 
testing  the  correctness  of  the  debtor  side  of  bank  account 
since  it  shows  the  total  of  deposits  which  the  firm  has  made 
there,  as  recorded  by  the  employe  of  the  bank,  while  the 
firm's  own  check  book  serves  as  a  test  of  the  correctness 
of  the  creditor  side  of  bank  account  since  the  stubs  of  the 
checks,  if  correctly  written  up  as  the  checks  are  drawn, 
show  the  amount  which  the  bank  has  been  called  upon  to 
pay  in  behalf  of  the  firm  to  its  creditors.  The  bank  account 
is  treated  exactly  the  same  as  the  cash  account  and  pay- 
ments of  cash  into  bank  are  credited  to  cash  and  debited  to 
bank,  while  withdrawals  of  actual  cash  from  bank  are 
treated  as  credits  to  bank  account  and  debits  to  cash.  If 
J.  P.  Morgan  gives  the  concern  of  Smith  &  Brown  a  check 
on  his  bank  in  liquidation  of  dry  goods  which  he  has  bought 
from  Smith  &  Brown,  this  then  means  a  creditor  entry  on 

J.  P.  Morgan's  account  ''Jan.  1  By  check $100,"  and 

appears  in  bank  account  (if  it  is  the  only  deposit  for  the 

day)   as  "Jan.  1  To  J.  P.  Morgan  check $100."    If 

John  W.  Gates  and  others  have  given  similar  checks  to  the 
concern,  the  items  may;  be  lumped  together  on  the  debtor 


THE  PRINCIPLES  OP  ACCOUNTING  59 

side  of  bank  account  as  ''Jan.  1  Deposit $500,"  al- 
though an  enumeration  of  the  names  would  be  preferable. 

Use  of  Commercial  Paper. 

In  many  cases  persons  who  buy  from  others  are  not  in 
position  to  pay  cash  or  (what  is  the  same  thing)  give 
checks  on  banks  payable  upon  demand.  They  want  time 
in  which  to  liquidate  their  obligations.  For  instance,  sup- 
pose that  James  Jones  buys  a  bill  of  $500  worth  of  goods 
from  Smith  &  Brown  expecting  to  retail  it  in  his  small 
shop.  He  may  not  have  the  $500  in  hand  and  may  want 
thirty  days'  credit  in  order  to  have  time  to  sell  the  goods 
and  realize  on  them,  at  least  in  part.  He  may,  therefore, 
arrange  with  Smith  &  Brown  at  the  outset  that  he  will 
not  be  required  to  pay  in  cash  but  that  the  goods  shall  sim- 
ply be  carried  on  his  "open"  account.  In  other  words  he 
makes  payment  only  in  ''credit" — that  is,  he  does  not 
make  any  immediate  payment  at  all.  How  shall  this  trans- 
action be  accounted  for?  In  the  first  place  it  evidently 
gives  rise  to  a  credit  entry  in  goods  account.  Supposing 
that  goods  is  already  debited  with  $4,000  (the  amount  orig- 
inally contributed  by  Richard  Brown  as  the  stock  of  goods 
with  which  to  start  business),  what  has  happened  has  been 
that  $500  worth  of  goods  has  been  drawn  from  goods  ac- 
count. Goods  account  or  the  stock  of  goods  on  hand  has 
parted  with  that  amount  and  must  therefore  be  credited  to 
that  extent.  This  would  make  the  goods  account  appear 
somewhat  as  follows : 

GOODS. 

Dr.  Cr. 


Jan.  1    iTo  capital  |$8,000    lljan.  1     [By  James  Jones  |$500 

James  Jones  must  now  be  represented  in  an  account  on 
the  books  which  will  appear  as  follows: 

JAMES  JONES. 
Dr. ^^- 


Jan.  1    iTo  goods 


$500 


60  HENRY  PARKER  WILLIS 

At  the  end  of  the  thirty  days  for  which  credit  was  ex- 
tended to  Jones,  the  latter  may  appear  and  pay  his  ''bill" 
by  handing  in  money  or  a  check,  in  which  case  the  account 
is  closed  as  described  above  (See  page  37).  But  it  is  more 
likely  that  at  the  outset  Smith  &  Brown  will  have  refused 
to  let  Jones  have  the  goods  unless  he  has  given  them  some 
piece  of  commercial  paper  as  evidence  of  his  indebtedness. 
Such  a  piece  of  commercial  paper  might  be  found  in  a 
*'note"  reading  as  follows: 

$500  New  York  City,  January  1. 

Thirty  days  after  date  for  value  received  I  promise  to  pay  to  the  order  of 
Smith  &  Brown  Five  hundred  dollars  with  interest  at  6  per  cent. 

James  Jones. 

Suppose  that  Smith  &  Brown  had  received  such  a 
''note,"  how  would  they  account  for  the  fact  that  it  had 
been  paid  in?  In  the  first  place  it  would  have  to  be  re- 
garded by  them  as  completely  liquidating  the  account  of 
James  Jones.  James  Jones'  account  then  would  appear  as 
follows : 

JAMES  JONES. 

Dr.  Cr. 


Jan.  1 


To  goods 


$500 


Jan.  1 


By  note  I  $500 


If  the  firm  was  in  the  habit  of  receiving  a  good  many 
such  notes  the  entry  on  the  credit  side  would  probably  be 
assigned  a  number  and  in  that  case  the  entry  might  be  "By 

bill  receivable  No.  1 $500."  The  receipt  of  this  paper, 

however,  would  make  it  necessary  to  account  for  that  fact 
elsewhere.  How  would  this  be  done?  The  bill  receivable 
is  not  cash  nor  is  it  as  yet  a  claim  on  a  bank.  It  is  neces- 
sary then  to  open  an  account  entitled  "Bills  Receivable." 
That  account  will  stand  as  follows : 

BILLS  RECEIVABLE. 

Dr.  Cr. 


Jan.  1 


To  bill  receivable  No.  1 


$500      II  I 

ir  r 


Any  other  form  of  commercial  paper  might  have  been 
given  and  accepted  by  the  concern  in  the  same  way.    For 


THE  PRINCIPLES  OF  ACCOUNTINa  61 

example,  the  concern  might  have  been  authorized  by  James 
Jones  to  ''draw"  on  him  at  thirty  days  for  the  goods.  Smith 
and  Brown  might  have  made  out  a  "bill  of  exchange" 
which  might  have  been  "accepted"  in  the  technical  sense  by 
James  Jones.  In  this  case  the  entry  would  probably  have 
been  made  in  the  account  of  James  Jones  and  of  bills  re- 
ceivable in  the  same  way — the  "paper"  received  would 
have  been  put  down  simply  as  "bill  receivable  No.  1." 
Then  in  a  "bills  receivable"  book  all  of  the  particulars 
about  the  given  bill  would  have  been  recorded  and  if  in- 
formation about  it  was  wanted  recourse  could  be  had  to  the 
bills  receivable  book  where  it  would  be  found  under  the  ap- 
propriate number.  Of  course  when  such  a  bill  receivable 
was  taken  by  the  concern  the  fact  would  have  been  re- 
corded in  the  day  book  and  would  doubtless  have  been 
journalized  as  explained  in  the  section  on  Books  (Page  28). 
The  accounting  thus  far  has  not  been  changed  at  all  in 
principle  or  method  but  is  exactly  identical  with  that  which 
would  have  been  adopted  had  payment  been  made  in  cash 
or  a  check,  the  bills  receivable  account  being  opened  in 
order  to  account  for,  or  keep  track  of,  bills  receivable  that 
have  come  in,  just  as  cash  takes  account  of  cash  and  bank 
account  takes  account  of  checks  received. 

Process  of  Discount. 

But  now  a  further  modification  is  necessary.  Suppose 
that  Smith  &  Brown  when  they  received  the  "note" 
given  them  by  James  Jones,  needed  the  cash  immediately, 
what  could  they  do*?  In  such  a  case  they  have  access  to 
their  bank,  one  of  whose  principal  functions  is  that  of  "dis- 
counting paper"  or  in  popular  language  "lending  money." 
Smith  &  Brown  take  to  the  First  National  Bank  the  note 
for  $500  payable  thirty  days  after  date  at  6  per  cent  and 
ask  the  bank  to  let  them  have  the  funds.  The  bank  thinks 
the  paper  good,  that  is,  it  believes  that  James  Jones  will 
he  likely  to  liquidate  at  the  maturity  of  the  note.    It  may 


62  HENRY  PARKER  WILLIS 

ask  Smith  &  Brown  to  ''endorse"  the  note  (whicli  they 
do  by  writing  their  firm  name  on  the  back  of  the  paper). 
The  bank  then  takes  over  the  note  as  one  of  its  assets. 
That  is,  in  this  case  it  practically  buys  the  note  from  Smith 
&  Brown  subject  to  Smith  &  Brown's  guarantee  that 
it  will  be  paid  at  maturity.  Wliat  effect  does  this  have 
upon  the  accounting?  Obviously  the  first  effect  is  that  of 
passing  the  note  out  of  the  hands  of  Smith  and  Brown  and 
into  that  of  the  bank.  This  means  a  credit  entr.y  in  bills  re- 
ceivable account  which  will  then  stand  as  follows: 

BILLS  RECEIVABLE. 

Dr.  Cr. 


Jan.  1    To  bill  rec.  No.  1 


$500 


Jan.  1 


By  bills  rec.  No.  1 
discounted 


$500 


This  means  that  the  bill  receivable  has  been  disposed  of 
and  of  course  the  corresponding  record  is  made  in  the  bills 
receivable  book  and  the  other  books.  If  the  bank  at  which 
the  note  was  disposed  of  has  paid  cash,  an  entry  is  made 
on  the  debtor  side  of  cash  account  for  $500  thus:  "To  bill 
rec.  No.  1  discounted. . .  .$500."  What  is  more  likely  is  that 
the  bank  will  not  pay  cash  but  will  credit  the  account  of 
Smith  &  Brown  with  the  amount.  This  means  that  the 
bank  account  kept  by  Smith  &  Brown  is  debited,  that  is, 
a  debtor  entry  of  $500  is  made  there  thus:  "To  bill  receiv- 
able No.  1  discounted $500."  Still  another  modifica- 
tion must  be  introduced.  The  note  which  was  given  by 
James  Jones  to  Smith  &  Browm  in  our  illustration  bore 
interest  at  6  per  cent  and  we  have  assumed  that  this  rate 
was  so  satisfactory  to  the  bank  that  it  simply  took  the  note 
over.  But  James  Jones,  as  we  have  seen,  might  have 
paid  in  the  form  of  a  bill  of  exchange.  This  would  have 
amounted  to  making  the  bill  simply  collectible  at  maturity 
without  any  interest.  Smith  &  Brown  were  willing  to  do 
this  for  the  sake  of  selling  the  goods.  The  bank,  however, 
is  not  willing  to  let  Smith  &  Brown  have  the  face  of  the 
note  without  any  interest  and  so  it  exacts  an  interest  or 


THE  PRINCIPLES  OP  ACCOUNTING  63 

*' discount."  If  the  rate  is  6  per  cent,  this  will  amount  to 
one-half  of  one  per  cent  for  the  thirty  days,  which  on  $500 
will  be  $2.50.  In  other  words,  the  bank  will  give  Smith 
&  Brown  only  $497.50  either  in  cash  or  in  the  form  of  a 
''deposit."  How  should  the  ''discount"  thus  exacted  by 
the  bank  be  accounted  for  on  the  books  of  Smith  & 
Brown  ?  They  have  parted  with  the  bills  receivable  so  that 
that  account  is  not  affected  at  all  in  this  case  any  more  than 
in  the  case  where  Smith  &  Brown  got  the  full  face  of  the 
note.  The  transaction  analyzed  is  simply  this — Smith  & 
Brown  have  paid  $2.50  for  immediate  cash.  The  transac- 
tion can  be  accounted  for,  then,  by  making  a  debtor  entry  in 
cash  account  or  bank  account,  as  the  case  may  be,  for  the 
$497.50  and  then  adding  a  debtor  entry  of  $2.50  in  profit 
and  loss  account;  or,  instead  of  the  latter  entry,  by  opening 
a  "discount  account"  and  making  a  debtor  entry  in  that 

thus:  "Jan.  1,  To  discount  on  bill  rec.  No.  1 $2.50." 

This  discount  account  represents  expense  on  the  debtor 
side  and  will  consequently  be  ultimately  transferred  to 
profit  and  loss  since  it  is  a  section  of  that  account  as  already 
explained  (see  p.  21  above).  Another  way  of  accounting  for 
the  transaction  would  be  to  make  the  debtor  entry  in  bank 
account  for  the  full  amount  of  the  face  of  the  note,  credit- 
ing bank  account  simultaneously  with  the  discount  or  cred- 
iting cash  with  the  discount  instead,  then  opening  the  dis- 
count account  in  the  same  way  and  debiting  it  or  debiting 
profit  and  loss  direct  as  already  explained.  What  would 
have  happened  then  would  have  been  that  Jones  paid 
Smith  &>  Brown  in  an  obligation  not  due  until  thirty  days 
from  date,  while  the  firm  in  order  to  get  immediate  use  of 
the  money  would  have  disposed  of  the  obligation  to  the 
bank  and  would  have  increased  its  bank  or  cash  account  to  a 
corresponding  extent,  the  transaction,  however,  involving 
it  in  an  expense  or  cost  known  as  ** discount,"  which  is 
reckoned  as  a  money  loss  to  the  concern  and  is  so  repre- 
sented.   Very  much  the  same  object  would  have  been  at- 


64  HENRY  PARKER  WILLIS 

tained  if  James  Jones  had  paid  to  Smith  &  Brown  the 
sum  of  $497.50  direct  and  in  order  to  do  this  had  borrowed 
from  the  bank.  In  that  case,  however,  Jones  would  not, 
perhaps,  have  been  able  to  get  the  accommodation  which 
the  bank  was  very  ready  to  give  so  long  as  the  note  was 
guaranteed  by  Smith  &  Brown. 

Bills  Dishonored. 

A  further  problem  in  accounting  presents  itself  in  case 
James  Jones  as  a  result  of  bad  business  finds  himself  un- 
able to  liquidate  his  note  when  it  is  presented  by  the  bank 
to  which  it  was  sold.  If  this  should  happen,  the  note  or 
draft  is  said  to  be  "dishonored."  The  bank  might  then 
proceed  against  Jones  and  endeavor  to  collect  the  amount. 
In  practice,  however,  it  would  not  take  that  course, 
but  would  return  the  obligation  to  Smith  &  Brown  from 
whom  it  was  originally  obtained  and  who  sold  it  or  had  it 
discounted.  The  bank  would  be  enabled  to  return  it  be- 
cause of  the  fact  that  the  obligation  had  been  endorsed  by 
Smith  &  Brown  at  the  time  when  they  first  entered  into 
relations  with  the  bank.  If  they  are  in  a  solvent  condition, 
they  will  have  to  receive  back  from  the  bank  the  note  or 
draft  which  was  given  to  them  by  Jones.  This  means  that 
they  will  have  to  pay  the  bank  what  they  originally  got 
from  it.  How  does  this  change  the  accounting*?  In  the 
first  place,  it  of  course  alters  the  account  with  the  bank, 
giving  rise  to  a  credit  entry  for  the  amount  which  should 
have  been  paid  by  James  Jones  had  he  honored  the  bill. 
This  credit  entry  in  bank  account  means  that  the  account  of 
the  firm  with  the  bank  is  decreased  (that  is,  its  net  balance 
is  lessened)  by  the  amount  in  question.  The  credit  entry 
in  bank  account  is  then  offset  by  a  corresponding  debtor 
entry  in  the  account  of  James  Jones  who  should  have  paid 
the  obligation.  Suppose  that  Jones  (as  heretofore  as- 
sumed) gave  the  bill  on  the  1st  of  January  for  thirty  days 


THE  PRINCIPLES  OP  ACCOUNTINa  65 

and  consequently  dishonors   it   on   the   30th  of  January. 
Then  his  account  will  stand  as  follows: 


Dt. 

JAMES  JONES 

. 

Cr. 

Jan.    1 
Jan. 30 

To  goods 
"    bill  rec.  No.  1 
dishonored 

$500 
500 

Jan.    1 

By  bill  rec.  No.  1 

$500 

This  shows  that,  although  during  the  30  days  interven- 
ing between  the  period  when  the  note  was  given  and  the 
date  when  it  is  received  back  the  account  of  James  Jones 
is  settled  or  balanced,  on  and  after  the  30th  of  January 
he  is  again  in  debt  to  the  firm  for  $500  which  now  appears 
as  a  debtor  entry  in  his  account.  The  question  what  to  do 
with  Jones  and  his  indebtedness  is  now  a  legal  problem  or 
a  problem  in  business  policy  and  is  one  with  which  the  ac- 
countant has  nothing  to  do  pending  the  time  that  Jones  is 
prevailed  upon  to  make  a  settlement.  His  default  may  be 
due  to  circumstances  over  which  he  has  no  control  and  in 
that  event  he  may  renew  the  bill,  in  which  case  his  account 
would  be  credited  with  his  renewal  thus  offsetting  the 
debit  entry  already  made.  Simultaneously  a  debit  entry 
for  the  new  bill  would  be  made  in  bills  receivable  account. 
The  firm  might  prefer  not  to  have  this  detailed  transaction 
appear  on  its  books  and  hence  might  suspend  entering 
anything  until  after  it  had  seen  Jones  and  had  come  to  an 
agreement  with  him.  If  the  situation  was  amicably  ad- 
justed, it  might  secure  an  extension  from  the  bank,  thus 
obviating  the  credit  entry  in  bank  account  already  referred 
to  and  rendering  it  unnecessary  to  make  any  other  entries 
on  the  books.  If  the  bill  had  not  been  discounted  but  had 
been  dishonored  by  Jones  when  directly  presented  by  the 
firm  on  the  30th  of  January,  the  entries  would  have  been 
a  credit  to  bills  receivable  and  a  debit  to  Jones'  account. 
This  would  simply  have  meant  that  Jones,  having  failed 
ito  pay,  was  Liable  to  the  firm  for  the  amount  of  his  dis- 
honored bill  while  bills  receivable  account  would  have  sur- 
rendered this  bill,  it  no  longer  being  a  live  piece  of  paper, 

B— VIII— 6 


66  HENRY  PARKER  WILLIS 

and  would  therefore  be  credited  for  it.  If  then  a  new  bill 
were  made  by  Jones,  the  transaction  would  be  treated  as 
an  entirely  new  one,  just  as  before — that  is,  Jones'  account 
would  be  credited  for  the  new  bill  while  bills  receivable 
would  be  debited.  If  Jones  on  settling  pays  some  interest 
in  cash  for  the  original  term  of  the  bill,  as  he  probably 
would  be  likely  to  do,  his  account  would  be  debited  with 
that  amount  and  a  corresponding  credit  would  be  entered 
in  profit  and  loss  because  interest  is  an  earning  or  gain. 
If  an  interest  account  were  kept,  separate  from  profit  and 
loss,  but  as  a  section  thereof,  the  interest  entry  would  be 
made  in  interest  account  and  subsequently  transferred  to 
profit  and  loss.  A  fresh  discount  payable  to  the  bank  for 
the  period  of  renewal  would  be  accounted  for  as  in  the  case 
of  the  original  discount. 

Bills  Payable. 

It  will  have  been  inferred  by  the  reader,  of  course, 
that  what  has  been  said  about  the  matter  of  bills  receiv- 
able is  true  in  precisely  the  same  way  of  bills  payable. 
Smith  &  Brown  may  do  just  as  Jones  did — pay  for  a 
consignment  of  goods  with  a  note  or  other  piece  of  com- 
mercial paper  running  for  30  days  or  some  other  period. 
That  is,  they  have  issued  an  obligation  against  themselves. 
Suppose  that  Smith  &  Brown,  after  organizing  with  a 
stock  of  goods  valued  at  $4,000,  concluded  that  their  stock 
was  inadequate  at  certain  points  and  so  bought  from  Wil- 
liam Wilson  $500  worth  of  goods  additional,  giving  Wilson 
a  note  for  thirty  days  for  the  amount.  Then  goods  ac- 
count would  look  as  follows : 

GOODS. 
Dr.  Cr. 


Jan.  1 
Jan.  1 


To  capital  $4,000 

"    Wm.  Wilson  500 


At  the  same  time  an  account  would  be  opened  for  Wil- 
liam Wilson  as  follows : 


THE  PRINCIPLES  OF  AOCOUNTINa  67 

WILLIAM  WILSON. 


Dr. 

Cr. 

Jan.  1    /To  bill  payable  No.  1 

$500 

Jan.  1 

By  goods 

$500 

Here  William  Wilson's  account  is  balanced  and  there 
is  an  entry  of  $500  on  the  debtor  side  of  goods  account. 
This  is  offset  by  opening  an  account  with  bills  payable 
as  follows: 

BILLS  PAYABLE. 

Dr. Cr. 

'  j  [  lljan.  1    I  By  bill  payable  No.  1        j 

I  I  II  I  |$500 

Here  the  note  given  to  William  Wilson  is  described  as 
**bill  payable  No.  1,"  and  an  account  intended  to  keep 
track  of  or  to  describe  bills  payable  is  opened  and  entitled 
*' Bills  Payable."  This  account  is  credited  with  the  bill 
payable  that  has  been  given  because  the  concern  has  parted 
with  a  bill  payable,  that  is,  has  created  a  liability  to  that 
extent  w^hich  thus  finds  its  place  on  the  books  and  in  so 
doing  offsets  the  debit  entry  made  in  goods  which  was  aug- 
mented by  the  $500  worth  of  commodities  which  was  re- 
ceived by  the  firm  on  consignment  from  William  Wilson. 
In  case  interest  is  paid  at  the  maturity  of  the  bill  payable, 
that  constitutes  a  loss  or  expense  to  the  business,  and  is 
so  entered  on  the  debtor  side  of  profit  and  loss  or  of  inter- 
est as  the  case  may  be.  In  case  the  firm  is  not  able  to 
meet  its  bill  payable  at  maturity,  it  will  probably  secure 
a  renewal,  and  may  entirely  omit  any  accounting  on  its 
books,  or  it  may  preferably  regard  the  bill  payable  as  paid 
at  maturity  and  an  entirely  new  bill  issued  which  of  course 
gives  rise  to  the  same  entries  over  again. 

Relation  between  Cash  and  Quasi-Cash  Accounts. 

From  what  has  been  said,  the  importance  of  the  rela- 
tionship between  cash,  bank,  bills  receivable,  and  bills  pay- 
able accounts,  is  plain.  These  four  accounts  constitute 
an  important  group  or  series  having  intimate  connection 
with  one  another  inasmuch  as  bank  account  loses  cash  to, 


68  HENRY  PARKER  WILLIS 

or  gains  cash  from,  casli  account,  wMle  cash  account  does 
the  same  with  respect  to  bank,  and  bills  receivable  may  be 
converted  into  bank  credit  or  cash  at  any  time  while  bills 
payable  maturing  become  claims  upon  and  thereby  reduce 
cash  or  bank  account.  It  is  thus  clear  that  a  concern  Avhich, 
in  making  a  showing  of  its  assets  and  liabilities,  merely 
states  the  amount  of  cash  on  hand  or  the  sum  to  its  credit 
in  bank  does  not  give  a  fair  idea  of  its  position.  The  inquirer 
wants  to  know  about  how  heavy  a  draft  is  likely  to  be 
made  upon  its  cash  or  its  bank  credit  by  reason  of  the 
approaching  maturity  of  bills  payable,  and  conversely  he 
needs  to  know  about  how  much  the  cash  or  bank  account 
is  likely  to  be  strengthened  by  the  maturing  of  bills  re- 
ceivable which  will  presumably  result  in  bringing  cash  into 
the  possession  of  the  concern.  If  the  concern  has  discount- 
ed its  bills  receivable  as  they  came  in  at  the  bank,  endors- 
ing them  of  course  as  it  is  obliged  to  do,  it  has  thereby 
created  what  is  called  a  *' contingent  liability,"  which  of 
course  does  not  appear  in  the  accounts,  as  explained,  be- 
cause it  is  assumed  that  every  maturing  bill  will  be  met. 
The  contingent  liability  of  the  concern  can  then  be  fairly 
and  truly  exhibited  to  the  student  of  its  condition  only  by  a 
statement  of  such  contingent  liabilities  or  by  the  adoption 
of  some  system  of  designating  on  the  books  of  the  concern 
the  amounts  that  were  realized  through  the  discounting 
of  bills  having  the  firm's  endorsement  and  which  therefore 
may  be  regarded  as  a  possible  liability  that  will  have  to 
be  met  in  case  the  persons  who  gave  the  bills  do  not  meet 
them  upon  presentation. 

VI.    GOODS  ACCOUNTS. 

Nature  of  Goods. 

In  dealing  with  the  goods  or  merchandise  account  of  a 
concern  we  practically  assumed,  when  speaking  of  the  sub- 
ject first,  that  there  was  no  entry  except  the  general  entry 


THE  PRINCIPLES  OP  ACCOUNTINa 


69 


representing  the  total  value  of  goods  wliich  had  been 
realized  and  placed  on  the  shelves  or  in  the  storage  rooms 
of  the  business  as  the  result  of  the  outlay  of  capital,  to 
await  the  disposal  by  sale  in  the  course  of  trade.  This 
might  theoretically  be  true — that  is,  goods  might  be  ob- 
tained by  direct  purchase  in  specified  amounts.  They 
would  come  in  as  independent  consignments  and  could  be 
entered  in  the  way  already  indicated.  As  a  matter  of  fact, 
goods  would  not  come  in  in  this  way  in  ordinary  business 
nor  would  the  single  entry  to  which  we  have  referred  be 
an  adequate  amount  of  information  for  a  concern  which 
was  beginning  business.  For  instance,  in  our  illustration 
of  a  case  where  Smith  &  Brown  were  supposed  to  put  in 
actual  property  instead  of  cash.  Brown  supplying  a  stock 
of  goods  worth  at  estimated  value  $4,000,  the  concern 
would  want  to  know  a  good  deal  more  about  the  details 
of  the  operation  than  would  be  indicated  in  that  way. 
Probably  in  such  a  case  a  complete  inventory  of  all  of  the 
items  of  goods  thus  put  in  by  Brown  would  be  made  out 
and  filed.  With  this  in  hand,  the  goods  account  might  be 
opened  in  the  way  indicated  or  with  an  entry  of  this  kind: 
*'To  capital;  goods  contributed  by  Richard  Brown  as  per 

inventory $4,000."    If  it  were  desired  to  do  so,  there 

would  be  no  reason  why  a  short  consolidated  statement 
of  these  goods  might  not  be  entered  on  the  debtor  side 
of  goods  account  thus : 

GOODS. 


Dr. 


Cr. 


Jan.H 


To  capital,  goods 
contributed  by 
Richard  Brown 
dress  goods        $3,000 
notions,  etc.,  50O 

other  goods  500 


$4,000 


The  statement  might  be  continued  to  any  desired  length, 
but  in  practice  it  would  be  better  to  refer  to  the  inventory 
which  gives  the  complete  detailed  statement  of  items  and 


70  HENRY  PARKER  WILLIS 

can  be  referred  to  as  occasion  may  demand  when  informa- 
tion about  tlie  quantity  of  goods  obtained  from  Brown 
at  the  start  is  wanted. 

Goods  on  Invoice. 

In  our  previous  illustrations  we  assumed  that  when 
the  concern  bought  goods  from  William  Wilson  it  simply 
made  a  corresponding  entry  showing  the  total  bought  from 
William  Wilson  and  thus  added  to  goods.  Of  course  it 
would  want  to  have  a  much  more  detailed  record  than  this 
of  the  items  it  received.  William  Wilson  would  bill  the 
goods  in  detail  in  the  form  of  an  invoice  which  would  be 
received  by  Smith  &  Brown  either  previous  to,  or  simulta- 
neously wdth,  the  receipt  of  the  consignment.  By  pre- 
serving this  invoice  in  a  book  established  for  the  purpose 
(see  p.  33  foregoing),  he  would  have  a  complete  record 
of  the  items  received  from  William  Wilson.  If  the  con- 
cern was  in  the  habit  of  buying  from  Wilson  regularlj^, 
it  would  want  to  know  what  entries  in  the  goods  account 
corresponded  to  Wilson's  shipments  and  so  in  making  the 
entry  now  under  consideration  it  would  assign  the  invoice 
a  number.     Then  the  entry  might  be  as  follows:     ^'To 

William  Wilson,  Invoice  No.  1 $500."    By  referring 

to  the  invoice  book  at  any  time  when  the  information  was 
desired,  it  could  then  be  seen  what  had  been  obtained  on 
that  occasion  from  Wilson. 

Goods  Returned. 

But  in  many  instances  Smith  &  Brown  would  not  find 
that  the  invoice  corresponded  exactly  to  what  they  wanted 
and  they  might  therefore  wish  to  return  the  goods.  In 
the  same  way  persons  who  bought  from  them  might  be 
dissatisfied  and  return  goods  to  Smith  &  Bro^Ti.  This 
would  give  rise  to  a  necessity  for  some  way  of  recording 
the  fact  that  goods  once  sold  or  bought  had  been  returned. 
In  practical  bookkeeping,  this  question  of  returns  is  a 


THE  PRINCIPLES  OF  ACCOUNTING  71 

matter  involving  some  little  difficulty  of  technique  in  order 
to  keep  exact  account  of  goods  received  or  sent  out. 
A  bare  reference  may  be  made  to  the  bookkeeping  phase 
of  the  matter  and  then  the  accounting  side  of  such 
transactions  can  be  explained.  It  is  likely  to  be 
necessary  to  make  such  returns  both  to  firms  from 
whom  goods  have  been  purchased  and  to  accept  them 
from  individuals  who  have  purchased  from  the  firm,  quite 
constantly.  The  wrong  goods  may  be  shipped,  or  they 
may  arrive  in  an  imperfect  condition,  or  returns  may  be 
necessary  for  other  reasons.  The  invoices,  as  we  have 
seen,  including  of  course  on  their  face  the  items  th-at  are 
now  to  be  returned,  have  been  recorded  or  filed  and  it  may 
be  that  the  proper  ledger  entries  (as  well  as  the  entries 
in  intervening  books)  have  been  made  up  before  the  neces- 
sity of  returns  is  discovered.  One  way  of  taking  care  of 
such  transactions  as  a  matter  of  original  entry  is  to  have 
a  book  dealing  with  ''inward  returns"  and  one  dealing 
with  ''outward  returns."  In  the  first  is  set  down  each  day 
the  goods  that  come  back  to  the  concern  from  persons  to 
whom  they  have  been  sold,  while  in  the  latter  is  set  down 
the  merchandise  returned  by  the  concern  to  firms  and  indi- 
viduals from  whom  it  has  been  bought.  The  inward  and 
outward  returns  books  are  thus  supplementary  to  the  pur- 
chases and  sales  books  and  the  purchases  book,  which 
shows  by  transactions  in  chronological  order  (see  p.  30) 
the  goods  that  have  been  obtained  by  the  firm, 
will,  when  studied  in  connection  with  the  outward 
returns  book,  show  the  net  amount  that  has  been  ob- 
tained by  the  concern  from  outsiders.  So  also  the  sales 
book  when  studied  in  connection  with  the  inward  returns 
book  will  show  the  net  amount  that  has  been  disposed  of 
by  the  concern  during  the  fiscal  period  under  considera- 
tion. We  may  now  glance  at  the  accounting  side  of  this 
question  of  returns.  Going  back  to  our  original  illustra- 
tion where  William  Wilson  sold  Smith  &  Brown  a  bill 


72 


HENRY  PARKER  WILLIS 


of  goods  worth  $500,  it  will  be  remembered  that  the  trans- 
action gave  rise  to  a  debit  entry  of  $500  in  goods  account 
and  a  credit  entry  of  $500  in  William  Wilson's  account. 
Now  suppose  that  a  day  or  two  after  receipt  of  the  con- 
signment, Smith  &  Brown  on  unpacking  the  goods  find 
that  one  item  consisting  of  100  yards  of  dress  goods  is 
damaged.  The  goods  are  shipped  back  to  Wilson  (assum- 
ing of  course  that  the  responsibility  for  the  damage  has 
been  fixed  upon  Wilson  and  that  it  has  not  occurred  en- 
route,  in  which  case  of  course  it  may  fall  on  someone  else) 
and  the  proper  entries  are  made  in  the  outward  returns 
book.  This  practically  reduces  the  amount  of  the  goods 
that  were  obtained  from  Wilson.  The  whole  of  the  goods 
has  been  entered  in  goods  account  on  the  debtor  side,  how- 
ever, and  so  this  item  is  entered  on  the  creditor  side  as 
offsetting  the  quantity  of  goods  represented  by  the  total 
invoice  on  the  debtor  side.  The  account  will  then  stand 
as  follows: 

GOODS. 


Dr. 


Cr. 


Jan.! 
Jan.  2 


To  capital 
"    William  Wilson 
(Inv.  No.  1) 


$4,000 
500 


Jan.  1 


By  returns  (Inv.  No.  1) 


$100 


This  shows  that  Wilson's  Invoice  No.  1  has  given  rise 
to  a  credit  in  goods  account  of  $100  which  means  that 
Wilson  has  had  that  value  of  goods  shipped  back  to  him. 
In  Wilson's  own  account  there  will  be  a  corresponding 
entry  and  his  account  will  stand  somewhat  as  follows : 


Dr. 


WILLIAM  WILSON. 


Cr. 


Jan.  1    ITo  goods  returned  I 

I     (Inv.  No.  1)  |$100 


Jan.  1    \By  goods  Inv.  No.  1 


$500 


This  process  would  be  reversed  if  James  Jones  who 
bought  a  bill  of  goods  from  Smith  &  Brown  had  been 
dissatisfied  with  one  item  in  the  consignment  and  had  con- 
sequently shipped  it  back  to  Smith  &  Brown.    It  may 


THE  PRINCIPLES  OP  ACCOUNTINa  73 

be  supposed  that  on  receiving  the  articles,  Smith  & 
Brown  look  over  the  stuff  which  has  thus  been  reconsigned 
to  them  and  find  it  damaged  as  alleged  by  Jones.  After 
recording  the  fact  of  the  receipt  in  the  inward  returns 
book,  and  duly  journalizing,  the  operation  will  result  in 
a  credit  entry  in  the  account  of  James  Jones  while  goods 
account  will  be  debited.  This  means  simply  that  the  stock 
of  goods  has  been  increased  by  the  amount  of  goods  that 
has  been  returned  while  the  claim  of  the  fiiTn  on  Jones 
has  been  diminished  by  the  sale  value  of  the  goods 
shipped  back.  In  order  to  avoid  frequent  entries  in  goods 
account,  the  amount  of  returns  inward  or  outward  may 
be  debited  or  credited  only  as  a  monthly  total,  leaving  the 
inward  and  outward  returns  books  and  the  personal  ac- 
counts of  Wilson,  Jones  and  others  to  exhibit  the  detailed 
facts. 

Consignments. 

In  what  has  been  said  about  dealings  in  goods  or  mer- 
chandise thus  far,  the  assumption  has  been  throughout  that 
the  goods  were  sold  for  cash,  or  on  credit,  or  else  on  the 
strength  of  a  bill  receivable  of  some  kind,  li,  is  not  al- 
ways possible  or  desirable  for  firms  to  deal  exclusively 
by  means  of  direct  sale  on  any  one  of  these  bases.  The 
firm  may  find  it  difficult  or  impossible  to  get  others  to 
run  the  risk  of  taking  its  goods  and  paying  for  them  in 
cash,  or  to  obligate  themselves  by  the  creation  of  commer- 
cial paper  to  pay  for  the  goods  at  a  specified  money  value 
at  some  time  in  the  future.  This  may  be  because  the  goods 
are  perishable  and  the  concern  to  whom  the  goods  are 
sent  does  not  want  to  run  the  risk  of  their  becoming  spoiled 
while  in  stock  or  it  may  be  that  the  firm  which  sells  the 
article  wishes  to  have  the  transaction  carried  on  through 
an  agent  in  order  to  insure  control  of  prices  or  for  some 
other  reason.  In  such  cases,  the  goods  are  disposed  of  on 
consignment  and  the  proper  accounting  features  have  to 


74  HENRY  PARKER  WILLIS 

be,  added  in  order  to  show  what  has  been  done.  Let  us 
suppose  that  Smith  &  Brown,  the  firm  of  our  illustration, 
desire  to  place  a  special  line  of  goods  with  Thomas  Taylor 
in  a  neighboring  town  in  order  that  Taylor  may  dispose 
of  them  to  his  customers.  Taylor  is  not  willing  to  take 
the  goods  on  his  own  risk  because  he  is  doing  a  small  busi- 
ness, but  he  tells  Smith  &  Brown's  agent  that  he  will 
accept  the  goods  on  consignment.  A  shipment  of  $100 
worth  of  "notions"  is  sent  him  at  once.  What  accounting 
will  be  necessary?  Taylor  has  not  bought  the  goods  and 
has  incurred  no  liability  whatever  for  them.  He  has 
merely  agreed  to  give  them  room  in  his  shop  and  if  they 
are  sold  to  return  the  money  to  Smith  &  Brown,  deduct- 
ing, say,  10  per  cent  commission  for  his  services.  The 
true  facts  in  the  situation  may  be  represented  in  the  follow- 
ing way.  A  consignment  account  for  Thomas  Taylor  is 
opened  in  the  ledger  and  this  is  debited  with  the  amount 
of  goods  shipped.  This  gives  rise  of  course  to  a  credit 
in  goods  account  which  may  read  "By  consignment  to 

Thomas  Taylor $100."    Suppose  Taylor  goes  on  and 

sells  the  goods  successfully,  the  price  in  such  cases  of  course 
being  fixed  by  Smith  &  Brown.  They  have  directed  him 
to  sell  the  goods  in  such  a  way  as  to  realize,  say,  $120. 
Taylor  takes  in  this  amount,  deducts  his  10  per  cent  com- 
mission, $12,  and  remits  a  draft  for  the  difference — $108 — 
in  favor  of  Smith  &  Brown.  This  will  give  rise  to  a 
debit  entry  in  bank  account  because  the  draft  is  presum- 
ably deposited  in  bank.  If  a  corresponding  credit  entry 
is  made  in  Thomas  Taylor's  consignment  account  the  trans- 
action will  have  been  correctly  represented.  Supposing 
that  Smith  &  Brown  had  to  pay  express  charges  amount- 
ing to  $1  on  the  consignment,  this  would  be  properly  rep- 
resented by  a  debit  entiy  of  $1  in  Thomas  Taylor's  con- 
signment account  because  that  would  result  in  correctly 
exhibiting  what  the  cost  of  the  goods  landed  in  Taylor's 
establishment  is  to  Smith  &  Brown.    The  outlay  for  ex- 


THE  PRINCIPLES  OF  ACCOUNTING  75 

press  charges  might  simply  have  been  debited  to  profit 
and  loss  or  to  freights  and  express  account  (for  ultimate 
transfer  to  profit  and  loss),  but  it  would  be  better  to  keep 
it  with  the  consignment  to  which  it  belongs  and  in  that 
case  the  entry  would  be  made  as  already  indicated. 
Thomas  Taylor's  consignment  account  might  then  look  as 
follows : 

CONSIGNMENT  ACCOUNT. 

(Thomas  Taylor.) 
Dr.  Cr. 


Jan.  1     iTo  goods  j$100.00  11  Jan.  30  I  By  draft  Thomas 

Jan.  1       "    express  charges  1.00  I     Taylor  as  per 


statement  $108.00 


|$1 


This  account  would  now  be  closed  by  entering  a  debit 

balance  as  follows:  "To  balance  to  profit  and  loss 

$8.00."  This  sum  would  then  be  entered  as  a  credit  in 
profit  and  loss  account  as  follows:  "Jan.  30,  By  Consign- 
ment Account  (Thomas  Taylor) $8.00."    So  far  the 

process  of  accounting  where  goods  are  shipped  on  con- 
signment has  presented  no  difficulty.  Taylor  has  been  a 
trustworthy  man  and  the  goods  have  been  safe  in  his  pos- 
session. The  assumption  of  the  accounting  has  been  merely 
that  a  certain  stock  of  goods  has  been  set  apart  in  a  safe 
place  to  be  disposed  of  by  Thomas  Taylor  and  this  expec- 
tation has  been  justified.  Suppose,  however,  that  Taylor 
has  no  success  in  selling  the  goods  so  that  the  time  comes 
when  the  books  are  to  be  closed  and  the  returns  from 
Taylor  amount  only  to  a  small  sum.  In  this  case  the  ac- 
count still  stands  open  and  the  balance  on  the  debtor  side 
representing  the  excess  of  the  goods  over  the  amount  which 
Taylor  has  remitted  in  cash  is  really  a  section  of  goods 
account  since  it  shows  goods  on  hand.  These  goods  are 
an  asset  and  will  be  so  represented  in  the  final  statement 
or  balance  sheet  the  concern  makes.  In  closing  the  con- 
signment account  the  goods  still  in  the  hands  of  Thomas 
Taylor  would  be  given  a  value  either  based  on  their  original 
shipping  value  or  else  based  on  a  statement  made  by  Taj^lor 


76  HENRY  PARKER  WILLIS 

as  to  the  present  worth  of  the  goods  and  this  amount  would 
be  credited  to  Thomas  Taylor's  consignment  account  be- 
fore balancing.  The  reader  will  remember  that  this  is  ex- 
actly the  same  method  of  treatment  that  was  indicated  in 
connection  with  the  closing  of  goods  account  itself.  The 
balance  of  the  account  then  represents  the  actual  profit 
made  on  that  portion  of  the  goods  which  has  been  sold.  If 
of  course  the  consignment  had  been  shipped  just  before 
closing  the  books  so  that  no  time  had  been  afforded  for 
Taylor  to  sell  anything,  the  account  would  be  closed  by 
simpty  entering  on  its  credit  side  a  value  corresponding 
to  that  of  the  goods  shipped  and  then  treating  the  value 
of  the  consignment  as  the  opening  entry  (debtor  side)  of 
Taylor's  consignment  account  for  the  ensuing  period.  In 
this  case  there  would  be  no  entry  to  transfer  to  profit  and 
loss  inasmuch  as  no  commercial  operation  would  have  been 
performed.  The  consignment  account  is  thus  really  a  sec- 
tion of  goods  account  and  Thomas  Taylor  has  not  figured, 
except  for  the  purpose  of  identification.  Suppose,  how- 
ever, that  Taylor,  knowing  the  desire  of  Smith  &  Brown 
to  be  closely  informed  of  how  the  sale  of  the  consignment 
is  going,  decides  simply  to  send  them  a  statement  and  to 
wait  before  remitting  until  he  can  collect  from  his  cus- 
tomers who  perhaps  have  bought  the  goods  on  credit. 
Taylor  reports,  let  us  say,  that  he  has  sold  $50  worth  of 
the  goods  at  the  end  of  the  first  week.  What  is  the  situa- 
tion? Taylor  has  sold  the  goods  and  has  either  received 
the  cash  for  them  or  else  the  promise  to  pay,  either  oral 
or  written,  of  his  customers.  He  is  therefore  liable  to 
Smith  and  Bro\^Ta  for  the  amount  of  his  sales.  Instead 
of  entering  anything  to  the  debit  of  bank  or  cash  account, 
therefore.  Smith  and  Brown  are  now  at  liberty  to,  and 
should,  open  a  personal  account  with  Thomas  Taylor  mak- 
ing a  debit  entry  to  open  as  follows:  '^Jan.  8,  By  goods 
as  per  statement.  .$50."  But  how  about  the  accounting 
of  Thomas  Taylor  himself,  or  to  keep  the  illustration  per- 


THE  PRINCIPLES  OF  ACCOUNTING  77 

feet,  how  about  the  accounting  of  Smith  &  Brown  if 
they  had  received  a  consignment  from  Thomas  Taylor? 
When  the  goods  were  received  no  account  needs  to  be 
opened.  Taylor  in  this  illustration  has  shipped  the  goods 
to  Smith  &  Brown  on  his  own  risk  and  the  latter  have 
received  them  but  they  have  not  become  liable  therefor. 
It  will  of  course  be  desirable  to  check  over  the  items  along 
with  the  invoice  and  make  sure  that  they  are  correctly 
stated.  A  detailed  memorandum  entered  in  a  memoran- 
dum book  which  may  be  called  ''Warehouse  Book,"  is 
desirable  simply  as  a  record,  and  this  practically  serves 
as  an  inventory  statement  of  all  original  consignments  sent 
to  and  received  by  the  firm.  Suppose,  however,  that  Smith 
&  Brown  sell  at  once  $50  of  the  consignment  they  have 
received  from  Thomas  Taylor.  Suppose  that  these  items 
were  sold  for  cash  over  the  counter.  Then,  of  course,  cash 
must  be  debited  for  the  amount  of  cash  taken  in,  or  bank 
account  must  be  debited  if  the  payment  is  made  in  checks. 
If  the  customers  are  known  to  the  firm  and  so  get  their 
goods  on  credit,  the  debit  entries  are  made  in  their  accounts 
for  the  amounts  that  they  buy.  What  has  happened  now 
is  that  the  firm  has  received  cash  or  bank  credit  or  claims 
upon  other  individuals  by  selling  goods  belonging  to  Thom- 
as Taylor.  Smith  &  Brown  then  must  open  a  personal 
account  with  Taylor  because  they  are  now  in  debt  to  him 
for  the  amount  that  they  have  received  as  above  indicated. 
A  credit  entry  showing  a  liability  on  the  part  of  Smith 
&  Bro^^^l  is  therefore  made  in  Taylor's  pei^sonal  account. 
If  the  firm  has  had  to  pay  any  shipping  expenses  or  others 
connected  with  the  consignment,  corresponding  debit  en- 
tries are  made.  Of  course  Smith  &  Brown's  commission 
on  Taylor's  goods  is  also  debited.  Wlien  the  consignment 
has  been  disposed  of,  the  difference  between  the  amount 
realized  on  the  goods  (as  shown  on  the  credit  side  of  Tay- 
lor's account)  and  the  amount  charged  against  the  goods 
for  expenses  and  commissions  (as  shown  on  the  debit  side 


78  HENRY  PARKER  WILLIS 

of  Taylor's  account)  is  ascertained.  This  is  the  net  sum 
owing  to  Ta.vlor.  Suppose  the  amount  is  $90  and  a  draft 
is  remitted  to  Taylor.  This  draft  is  a  credit  in  bank  ac- 
count and  of  course  is  charged  to  Taylor's  personal  ac- 
count as  a  debit.  The  account  can  now  be  balanced  and  the 
difference  between  the  amount  received  for  the  goods  on 
the  one  hand  and  the  amount  remitted  to  Taylor  plus  the 
expenses  on  the  other  will  be  Smith  &  Brown's  com- 
mission. This  sum  can  now  be  credited  to  profit  and  loss 
account  because  it  represents  a  clear  gain  or  profit. 

Trading  Accounts. 

The  principles  which  have  just  been  set  forth  in  con- 
nection with  consignments  may  be,  and  customarily  are, 
carried  a  good  deal  further  in  connection  with  certain 
phases  of  business  which  may  most  conveniently  be  ex- 
plained at  this  point.  The  reader  will  have  noticed  that 
in  analyzing  consignment  accounts  we  endeavored,  for 
reasons  there  stated,  to  apportion  the  actual  direct  ex- 
pense incurred  in  connection  with  a  consignment  to  that 
particular  consignment,  the  reason  assigned  for  so  doing 
being  that  it  was  desirable  to  know  exactly  what  the  par- 
ticular venture  in  question  had  cost  the  concern.  The  same 
idea  works  out  in  very  much  greater  detail  as  soon  as  a 
business  develops  into  a  concern  of  any  degree  of  complex- 
ity or  becomes  involved  in  operations  of  large  size  involv- 
ing several  factors  for  their  successful  completion.  It  then 
becomes  exceedingly  desirable  to  know,  so  far  as  possible, 
which  expenses  have  been  incurred  for  certain  transac- 
tions. Evidently,  unless  this  can  be  kno^m,  the  concern 
has  no  definite  idea  whether  it  is  doing  a  profitable  busi- 
ness in  those  lines  or  not.  Tlie  sum  total  of  the  business 
may  show  a  small  profit  and  yet  there  may  be  a  very 
shrewd  suspicion  that  some  of  the  operations  in  which  the 
concern  is  engaged  result  in  actual  losses.  Whether  they 
do  so  or  not  cannot  be  told  because  the  special  expenses 


THE  PRINCIPLES  OF  ACCOUNTING  79 

incurred  in  connection  with  them  are  not  segregated.  It 
is  this  idea  and  the  necessity  of  apportioning  expenses 
and  costs  that  gives  rise  to  the  necessity  for  cost  account- 
ing— a  necessity  which  will  be  considered  later  on  in  this 
treatment.  At  this  point  it  is  enough  to  say  that  in  keep- 
ing account  with  goods  it  is  oftentimes  not  desirable  to  have 
a  distinct  separation  of  expenses  from  the  goods  in  con- 
nection with  which  expenses  are  incurred  but  it  is  desirable 
to  have  expenses  so  charged  as  to  bring  them  into  close  jux- 
taposition with  the  operations  that  have  given  rise  to  them. 
For  example,  in  the  case  of  the  small  operation  just 
studied  in  which  Smith  &  Brown  and  Thomas  Taylor 
were  supposed  to  be  participants,  suppose  that  Smith  & 
Brown  had  been  put  to  rather  heavy  expense  in  transmit- 
ting the  goods  and  that  the  expenses  of  shipping,  all  told, 
came  to  $9,  whereas  the  profit  was  only  $8.  Evidently  if 
this  consignment  was  one  of,  say,  one  hundred  or  more 
and  if  the  outlays  for  express  and  freight,  insurance,  etc., 
had  simply  been  charged  in  lump  sums  chronologically  to 
expense  account,  insurance  account,  etc.,  the  firm  would 
have  had  no  way  of  knowing  at  the  end  of  the  month 
whether  there  had  been  an  actual  profit  in  the  Taylor  busi- 
ness or  not.  Now  exactly  the  same  thing  is  true  on  a  much 
larger  scale  where  the  concern  handles  several  lines  of 
goods  under  its  own  roof.  For  example,  suppose  that 
Smith  &  Brown  decide  to  make  their  business  a  small 
department  store  and  in  one  department  they  handle  dry 
goods,  in  another,  groceries,  and  in  another,  house  equip- 
ment and  furnishings  of  various  kinds.  It  is  found  that 
a  certain  amount  of  freight,  etc.,  has  to  be  paid  and  a  cer- 
tain amount  of  wages  for  salesmen,  etc.,  has  to  be  laid  out 
while,  let  us  suppose,  the  business  has  grown  quite  rapidly 
so  that  it  is  not  possible  for  the  salesmen  to  shift  about 
from  one  department  to  another.  Smith  &  Brown  have 
been  keeping  their  goods  account,  wages  account,  freight 
and  express  account,  etc.,  as  general  accounts,  during  the 


80  HENRY  PARKER  WILLIS 

first  six  months  of  their  life,  simply  entering  in  each  the 
amounts  expended  without  any  reference  to  whether  they 
were  incurred  in  selling  dry  goods,  groceries,  or  house- 
wares. On  July  1,  they  decide  to  make  a  change  and  the 
books  are  closed.  After  taking  inventory,  it  is  found  that 
there  is  left  over  from  the  transactions  of  the  preceding 
six  months  a  stock  valued  in  all  at  $6,000,  which  is  equally 
divided  between  dry  goods,  groceries,  and  house-wares. 
The  opening  entry  in  the  goods  account  on  the  old  plan 
would  now  evidently  be  as  follows  (on  the  debtor  side): 

*'July  1,  To  stock  on  hand $6,000."  But  it  is  clear  that 

there  would  be  an  advantage  in  dividing  the  goods  account 
up  into  three  sections,  one  corresponding  to  each  of  the 
departments.  These  might  be  entitled  "Goods  (dry-goods 
department)  Account,"  "Groods  (groceries  department) 
Account,"  and  *' Goods  (house-wares  department)  Ac- 
count." In  each  of  these  there  would  be  a  debit  entry  of 
the  total  amount  on  hand  as  shown  per  inventory  (in  this 
case  by  the  terms  of  our  supposition)  $2,000.  Then  in 
carrying  on  the  accounting  for  the  dry-goods  department 
there  would  be  entered  on  the  debit  side  not  only  tiie  value 
of  any  additions  that  might  be  made  to  the  stack  m  that 
particular  department  but  also  any  expenses  that  were 
actually  incurred  for  the  purpose  of  getting  it  placed  on 
the  shelves  or  of  getting  it  off  the  shelves  and  into  the 
hands  of  the  consumers.  On  the  credit  side  would  be  en- 
tered of  course  the  amount  sold  and  in  addition  any  spe- 
cific profits  or  earnings  that  might  have  accrued  through 
the  efforts  of  that  particular  department.  Suppose  that 
during  the  month  of  July  one-half  the  stock  of  goods 
(worth  $1,000  inventory  value)  was  sold  for  $1,200,  while 
during  the  same  period  it  was  necessary  to  pay  wages  to 
the  amount  of  $100,  freight,  etc.,  to  the  amount  of  $25,  and 
incidental  expenses,  $10.  Then  the  account  for  that  de- 
partment would  stand  as  follows: 


THE  PRINCIPLES  OF  ACCOUNTING 


81 


Dr. 


GOODS. 

(Dry-goods  Department.) 


Cr. 


July  1 
July  31 
July  31 
July  31 


To  stock  on  hand 
"    wages 
"    total  freights 
"    miscellaneous 


$2,000 

100 

25 

10 


July  31   By  sales 

July  31     "    goods  on  hand 


$1,200 
1,000 


Here  the  section  of  the  goods  account  which  deals  with 
dry  goods  shows  that  articles  which  cost  the  firm  $1,000 
have  been  parted  with  and  in  their  stead  $1,200  in  cash 
has  been  received,  but  that  in  this  process  of  changing 
goods  into  cash  there  has  been  incurred  an  expense  amount- 
ing fo  $135.    At  the  end  of  the  month,  assuming  that  the 
goods  still  left  on  hand  are  worth  as  much  as  they  ever 
were,  there  is  a  net  profit  in  the  department  of  $65,  or  in 
other  words  the  department  has  paid  for  its  own  individual 
expenses  and  it  has  $65  left  over  which  it  can  contribute 
to  the  business  for  the  purpose  of  paying  profits  on  in- 
vested capital  or  general  expenses.    General  expenses  are 
mentioned  for  the  reason  that  no  mention  has  been  made 
of  these  among  the  debit  entries  in  dry-goods  department 
account.    In  the  form  which  we  have  used,  the  general  ex- 
penses would  just  as  formerly  be  carried  in  the  general 
expense  accounts — rent,  taxes,  etc. — and  ultimately  trans- 
ferred to  profit  and  loss.    It  might  be  possible  to  assign 
some  of  these  to  the  departmental  account — for  instance, 
by  ascertaining  what  proportion  of  the  expenses  of  various 
kinds,  such  as  insurance,  was  incurred  for  groceries,  what 
for  dry  goods  and  what  for  house-wares.    Beyond  a  certain 
point,  however,  this  apportionment  would  become  rather 
uncertain,  and  it  would  be  preferable  to  carry  it  in  the 
general  expense  accounts  as  one  of  the  inevitable  concomi- 
tants to  the  running  of  the  business  rather  than  to  try  to 
segregate  it. 

The  question  how  far  such  segregation  will  in  practice 
be  expedient  and  desirable  is  a  question  that  can  be  settled 
only  as  the  conditions  of  the  business  require  and  about 


B— VIII— 6 


82  HENRY  PARKER  WILLIS 

which  no  definite  rule  can  be  laid  down.  The  fact  remains 
that  in  every  business  involving  either  the  establishment 
of  departments  under  one  roof  or  the  establishment  of 
branches  in  different  places  some  application  of  this  idea 
of  segregation  of  expenses,  coupled  with  their  assignment 
to  the  particular  business  operations  that  have  given  rise 
to  them,  is  called  for.  Where  such  an  arrangement  is  made 
upon  an  accounting  basis  like  that  indicated  above,  the 
account  is  called  a  *' trading  account"  and  it  is  theoretically 
said  to  be  a  ''mixed"  account,  inasmuch  as  it  involves  both 
goods  entries  and  expense  entries,  which  latter  theoretically 
pertain  to  profit  and  loss  accounting.  Reference  will  be 
made  to  this  matter  at  a  later  point  in  the  discussion  (see 
p.  145). 

Closing  Inventory. 

Reference  has  already  several  times  been  made  to  the 
question  of  an  inventory  and  it  has  been  pointed  out  that 
such  a  statement  of  items  as  are  taken  over  by  the  business 
and  constitute  its  stock  in  trade  is  needed  at  the  outset 
and  should  be  filed  in  detail  as  one  of  the  original  records 
of  the  concern.  It  is  clear  from  what  has  been  said  thus 
far  that  as  goods  are  sold  the  stock  is  reduced,  while  as 
invoices  and  bills  of  goods  are  purchased  it  is  increased. 
The  accounting  system  which  has  been  described  keeps 
track  of  the  outflow  of  goods  in  exchange  for  money  and 
of  the  inflow  of  new  goods  in  exchange  for  the  firm's 
money.  If  it  were  possible  to  trace  every  item  through 
the  various  accounts  to  which  it  is  assigned  in  the  process 
of  accounting  and  if  it  be  assumed  that  no  losses  whatever 
occur  in  the  stock  of  goods  through  waste,  theft,  etc.,  the 
difference  between  the  original  inventory  and  the  items 
sold  would  show  the  items  remaining.  It  would  not  show 
the  value  of  the  items  remaining  because  their  original 
value  is  set  down  as  the  cost  or  basic  value  to  the  concern 
while  the  values  at  which  the  sold  items  are  recorded  on 


THE  PRINCIPLES  OF  ACCOUNTING  83 

the  books  are  the  values  which  the  concern  has  established 
as  proper  rates  of  remuneration  to  it  and  are  normally  an 
advance  over  the  original  cost  of  these  articles.  But  it 
is  plain  that  to  ascertain  the  amount  of  the  stock  left  on 
hand  in  this  way  would  be  practically  impossible  as  a  mat- 
ter of  actual  procedure.  The  method  adopted  is  to  take 
an  inventory  of  the  goods  at  the  close  of  each  fiscal  period. 
This  inventory  shows  the  number  of  items  of  each  class 
of  goods  remaining  on  hand,  and  they  may  then  be  assigned 
a  value  at  their  present  probable  worth,  or  they  may  be 
given  the  value  which  is  determined  by  what  they  origin- 
ally cost  to  the  concern.  Which  one  of  these  modes  of  as- 
signing the  value  of  the  goods  will  be  followed  will  of 
course  depend  upon  a  variety  of  considerations  among 
which  the  character  of  the  goods  is  an  important  one.  If 
they  have  not  varied  much  in  value,  being  of  a  staple  char- 
acter, there  may  be  no  particular  reason  for  trying  to  re- 
value them. 

VII.  PLANT  AND  PROPERTY  ACCOUNTS. 

Relation  to  Preceding  Discussion. 

In  everything  that  has  been  said  thus  far,  it  has  been 
assumed  that  the  concern  of  which  we  were  speaking  was 
primarily  engaged  in  the  retailing  of  goods  and  that  in 
carrying  on  this  business  it  did  not  require  very  much  in- 
vestment in  things  other  than  those  which  constituted  the 
basis  of  its  sales.  True,  in  analyzing  the  business  of  Smith 
&  Brown,  we  assumed  that  one  item  of  the  investment 
of  the  concern  was  a  shop  or  building  in  which  the  busi- 
ness was  to  be  conducted.  But  we  fairly  implied  that  this 
might  be  regarded  as  a  substantially  stable  investment 
which  did  not  change  materially  in  value  and  which  could 
be  looked  upon  simply  as  a  part  of  the  assets  of  the  con- 
cern permanently  placed  in  a  form  which  did  not  yield 
any  direct  income,  but  which  nevertheless  enabled  the  con- 


84  HENRY  PARKER  WILLIS 

cern  to  avoid  the  expense  of  rent  and  thereby  made  it 
worth  while  to  use  the  funds  of  the  business  in  that  way. 
It  is  now  necessary  to  observe  that  a  business  fiirm  is  not 
necessarily  in  the  position  which  has  thus  been  sketched 
but  that  almost  every  business  is  obliged  to  invest  a  part 
of  its  funds  in  ]3hysical  assets  which  are  not  the  basis  of 
its  buying  and  selling  process  but  which  afford  the  means 
for  going  on  with  the  enterprise.  Thus,  for  instance,  the 
retail  shop  of  the  kind  we  have  been  speaking  of  may  own 
its  own  building  and  that  building  may  not  change  very 
largely  in  value,  but  it  is  further  probable  that  in  addi- 
tion to  the  building  the  concern  will  have  had  to  invest 
a  substantial  sum  in  furniture,  fixtures,  and  the  like,  and 
that  these  articles  will  wear  out  as  time  goes  on.  The 
same  thing  is  true  in  a  much  higher  degree  of  a  concern 
that  is  engaged  in  manufacturing  and  puts  part  of  its  cap- 
ital into  tools,  machinery,  and  the  like.  In  speaking  of  the 
question  of  inventories  at  the  close  of  the  last  section,  we 
noted  that  a  concern  may  find  that  its  stock  of  goods  un- 
sold has  changed  in  value  somewhat  during  a  fiscal  period, 
so  that  in  restating  their  value  for  the  purpose  of  closing 
the  books,  the  concern  is  obliged  to  recognize  an  element 
of  loss,  or  possibly  of  gain,  due  to  fluctuations  in  the  price 
of  articles  remaining  unsold.  Where  a  concern  carries  on 
hand  a  large  stock  of  raw  material  of  a  kind  that  fluctuates 
in  value  from  day  to  day  it  may  appear  that  at  the  end 
of  a  fiscal  period  the  stock  on  hand  is  w^orth  very  much 
less  or  very  much  more  than  it  was  at  the  beginning  and 
that  there  is  here  an  element  of  gain  or  loss  which  the  con- 
cern is  not  responsible  for  in  so  far  as  relates  to  its  active 
business  transactions,  although  of  course  it  may  have 
adopted  a  conscious  business  policy  which  looked  to  the 
carrying  of  a  large  stock  of  raw  material  or  goods  with  a 
definite  view  to  probable  appreciation  in  value.  It  will, 
however,  be  found  that  in  every  concern,  whatever  ele- 
ments of  appreciation  or  growth  in  value  there  may  be, 


THE  PRINCIPLES  OF  ACCOUNTINa  85 

there  is  always  an  element  of  depreciation.  This  depre- 
ciation is  the  consequence  of  the  wearing  out  of  assets  and 
if  the  true  condition  of  the  business  is  to  be  correctly  rep- 
resented, it  must  be  allowed  for.  The  problem  thus  indi- 
cated gives  rise  to  the  question  of  accounting  for  depre- 
ciation (and  of  course,  conversely,  for  appreciation).  This 
is  present  in  every  concern.  It  is  therefore  necessary  to 
consider  with  care  the  accounting  phases  of  this  question. 

Plant  and  Property  Accounts  Described. 

Under  ordinary  conditions,  a  concern  which  is  starting 
in  business  and  which  has  invested  a  part  of  its  cap- 
ital in  fixed  forms  will  seek  to  classify  these  fixed  forms 
by  kinds  or  groups  and  to  open  an  account  with  each 
kind  or  group.  Thus,  recurring  to  the  affairs  of  Smith  & 
Brown,  it  will  be  remembered  that  we  supposed  that  they 
put  $4,000  into  a  shop  for  the  conduct  of  their  business 
or  that  they  included  as  a  part  of  their  capital  to  start 
with  a  shop  valued  at  $4,000.  This  was  represented  at 
the  opening  of  business  in  an  account  headed  real  estate 
and  opened  somewhat  as  follows : 

REAL  ESTATE. 
Dr.  Cr. 


Jan.  1 


To  capital,  building 
contributed'  by 
John  Smith, 


$4,000 


Now  let  us  change  the  terms  of  this  supposition  some- 
what by  assuming  that  the  value  of  this  building  was  only 
$2,000,  but  that  John  Smith  had  contributed  in  addition 
show  cases  and  the  like  set  up  in  place  and  worth  $1,000, 
while  we  may  further  assume  that  he  had  supplied  delivery 
wagons  and  horses  valued  at  $1,000.  Under  this  supposi- 
tion, it  is  clear  that  instead  of  entering  $4,000  as  the  value 
of  the  building  contributed  by  John  Smith  the  entry  would 
be  changed  to  $2,000.    It  would  then  be  desirable  to  open 


86  HENRY  PARKER  WILLIS 

an  account  with  fixtures  Avliich  would  be  done  somewhat 
in  the  following  manner: 

FIXTURES. 
Dr.  Cr. 


Jan.  1 


To  capital,  cases,  etc.,  con- 
tributed by  John  Smith 


$1,000 


An  account  would  likewise  be  opened  with  horses  and 
wagons  or  preferably  one  with  horses  and  one  with  wagons. 
Supposing  that  the  establishment  had  three  horses  and 
three  delivery  wagons  the  horses  being  assumed  to  be 
worth  $450  and  the  wagons  $550,  accounts  might  be  opened 
as  follows: 

HORSES. 


Dr. 

Cr. 

Jan.  1 

To  capital,  3  horses  con-   | 
tributed  by  John  Smith  $450 

WAGONS. 

Dr. 

Cr. 

Jan.  1     To  capital,  3  wagons  con- 
tributed by  John  Smith  $550 

All  of  these  accounts  might  have  been  grouped  together 
perhaps  under  the  head  of  "Plant  and  Property  Account" 
with  subsections  for  the  different  kinds  of  plant  and  prop- 
erty, as  Real  Estate,  Fixtures,  Horses,  Wagons,  etc.,  just 
as  in  the  case  of  goods  we  saw  fit  to  subdivide  it  into  sec- 
tions corresponding  to  the  various  departments  whose  op- 
erations it  w^as  desired  to  analyze.  In  either  case,  the  re- 
sult is  the  same.  That  is  to  say,  John  Smith's  portion 
of  capital  account  carries  a  credit  entry  of  $4,000,  which 
indicates  the  accepted  valuation  of  the  things  which  he 
has  put  into  the  business.  These  various  things  at  their 
respective  values  are  now  scattered  through  a  series  of 
accounts,  the  debtor  entry  in  each  of  which  is  the  par- 
ticular asset  which  gives  its  name  to  the  account  and  which 
is  set  down  there  at  a  total  valuation  corresponding  to  what 
it  is  estimated  to  be  worth  in  proportion  to  the  other  items 
of  property.    The  sum  total  of  these  debtor  entries  in  the 


THE  PRINCIPLES  OP  ACCOUNTING  87 

property  accounts  represents  the  total  that  has  been  put 
in  by  John  Smith  and  corresponds  to  the  total  creditor 
entry  in  his  section  of  capital  account,  or  $4,000.  Thus 
far  the  innovation  made  upon  our  original  simple  supposi- 
tion is  merely  that  of  assuming  that,  instead  of  putting 
in  a  single  class  or  kind  of  asset,  he  puts  in  a  number  of  dif- 
ferent kinds  of  assets  which  are  classified  as  already  in- 
dicated for  purposes  of  analysis  or  convenience.  The  situ- 
ation would  have  been  the  same  if  he  had  put  in  $4,000  of 
cash  at  the  start,  and  if  then  this  cash  had  been  laid  out  in 
buying  for  the  firm  the  items  of  plant  and  property  w^hich 
it  actually  needed.  A  similar  classification  would  have 
been  adopted  had  the  concern  been  engaged  in  some  other 
line  of  business,  except  that  the  classification  would  have 
corresponded  with  the  particular  forms  of  business  assets 
which  would  then  have  been  secured.  Thus  if  Smith  & 
'Btovtd.  had  been  conducting  a  bank  and  John  Smith  had 
put  in  $4,000  cash,  this  amount  might  have  been  spent  in 
part  for  the  purchase  of  a  banking  establishment,  in  part 
for  furniture  and  fixtures  and  in  part  for  safes  or  vaults. 
Accounts  would  then  have  been  opened  with  Banking 
House,  Fixtures,  and  Safe  and  Vaults.  Or  if  Smith  & 
Brown  had  been  engaged  in  the  printing  business,  the  ac- 
counts might  have  been  Real  Estate,  Presses,  Typesetting 
Machines,  etc.,  the  classification  being  developed  as  far  as 
was  deemed  desirable  and  each  of  these  accounts  carry- 
ing as  its  opening  debtor  entry  the  amount  actually  spent 
in  getting  that  particular  kind  or  class  of  machinery  or 
fixed  plant  installed. 

Depreciation. 

Suppose  the  concern  of  Smith  &  Brown,  engaged  in 
the  dry-goods  business,  continues  its  operations  for  a  year 
and  then  wants  to  know  where  it  stands.  Looking  over 
the  property  it  finds  that  the  building  has  been  somewhat 
damaged,  there  being  an  estimated  loss  of  $200  in  value. 


88  HENRY  PARKER  WILLIS 

It  finds  that  tlie  fixtures  as  the  result  of  a  year's  hard 
wear  have  deteriorated  to  the  extent  of  $100,  while  one 
of  the  delivery  wagons  in  an  accident  has  been  injured, 
thereby  resulting  in  a  loss  of,  say,  $150.  How  can  the  con- 
cern represent  these  facts  in  such  a  way  as  to  make  a  cor- 
rect showing  at  the  end  of  the  year?  Evidently  if  it  merely 
assumes  that  the  building,  fixtures  and  wagons  are  worth 
the  same  as  they  were,  it  will  have  overlooked  a  total  loss 
or  expense,  incurred  during  the  year,  amounting  to  $450. 
If  it  made  no  effort  to  record  this,  but  simply  assumed 
that  the  fixed  assets  were  worth  as  much  at  the  end  as 
they  were  at  the  beginning  of  the  year,  it  would  be  mis- 
representing its  profits  by  $450,  because  if  the  concern  were 
to  be  liquidated  the  money  value  of  its  fixed  assets  would 
be  $450  less  than  when  they  were  originally  taken  over 
by  the  firm.  This  would  mean  that,  if  the  concern  first 
replaced  the  capital  at  the  same  amount  at  which  it  was 
originally  stated,  it  would  have  $450  less  cash  than  the 
books  now  show.  Some  regular  and  recognized  way  of 
representing  this  depreciation  must  therefore  be  deter- 
mined on  and  put  into  effect. 

** Writing  Down"  the  Assets. 

The  most  obvious  way  of  recording  depreciation  of  the 
kind  already  described  would  be  that  of  ascertaining  the 
value  of  the  assets  at  the  end  of  the  year,  and  then  making 
the  corresponding  entries  in  the  accounts.  If,  for  example, 
it  was  found  that  the  building  owned  by  the  concern  had 
lost  $200  in  value  as  Just  assumed,  the  real  estate  ac- 
count (described  on  p.  85)  would  have  a  credit  entry 
somewhat     as     follows:     *' December     31,     By     damage 

through  wear  and  tear $200."     The  corresponding 

debit  entry  would  appear  in  profit  and  loss  as  * 'December 

31,  To  damage  to  building $200."    This  would  merely 

mean  that  in  footing  up  profit  and  loss  account  an  extra 
sum  of  $200  was  recorded  on  the  debit  or  expense  side 


THE  PRINCIPLES  OP  ACCOUNTINa  89 

and  that  in  that  way  the  showing  of  profit  was  reduced 
$200  below  what  it  would  otherwise  have  been.  This  would 
mean  that  if  the  showing  of  profit  otherwise  made  was, 
say,  $500  it  would  now  be  only  $300.  In  other  words,  if 
the  concern  had  expected  to  have  $500  of  free  cash  to  dis- 
tribute in  dividends,  it  would  now  find  that  it  was  disap- 
pointed in  this  expectation,  since  it  would  have  only  $300. 
But  the  extra  $200  would  remain  in  the  possession  of  the 
concern  in  the  form  of  cash.  What  would  have  happened 
then  would  have  been  that  the  concern  had  itself  con- 
sciously put  aside  or  retained  in  the  business  $200  repre- 
senting the  value  of  destroyed  or  wasted  assets  which  have 
been  reduced  in  value,  by  deducting  that  amount  from  the 
gross  profits  of  the  year.  If  the  same  plan  were  applied  to 
the  fixtures  account,  horses  account  and  wagons  account, 
the  result  would  be  to  retain  in  the  hands  of  the  business  an 
amount  of  extra  cash  which,  if  expended,  would  restore 
the  fixed  assets  to  their  original  value.  So  far  the  account- 
ing would  have  been  adequate,  because  it  would  have  indi- 
cated the  reduction  in  the  value  of  the  assets,  the  deduc- 
tion from  profits  and  the  increase  of  cash  to  correspond. 
It  is  clear,  however,  that  if  this  process  were  continued, 
the  capital  assets  would  be  gradually  reduced  and  it  would 
give  rise  to  corresponding  additions  to  cash  in  hand.  This 
would  mean  that  one  of  three  uses  would  have  to  be  made 
of  the  cash  thus  accumulated:  (1)  It  might  be  directly 
reinvested  in  restoring  the  capital  assets  to  their  original 
condition.  In  that  event  an  entry  would  be  made  in  the 
proper  accounts,  as  fixtures,  etc.,  on  the  debit  side.  This 
entry  would  represent,  say,  in  the  ease  of  the  building,  the 
fact  that  $200  (the  amount  of  the  wear  and  tear)  had 
been  put  back  into  the  concern,  thus  restoring  the  build- 
ing to  the  same  original  value  with  which  it  started;  or 
(2)  the  cash  might  be  set  aside  as  a  distinct  cash  fund 
saved  for  the  purpose  of  ultimate  replacement  of  assets; 
or  (3)  it  might  be  deemed  wise  to  use  this  cash  in  extend- 


90  HENRY  PARKER  WILLIS 

ing  the  business  by  putting  it  into  the  purchase  of  a  larger 
stock  of  goods  or  other  floating  assets.  It  is  well  to  note 
that  in  every  business  there  will  regularly  be  a  certain  de- 
mand for  ordinary  repairs,  renewals,  replacements  and  the 
like.  These  outlaj^s  are  a  part  of  ordinary  running  expens- 
es and  should  be  dealt  with  in  precisely  the  same  way  as 
other  ordinary  running  expenses.  Such  outlays  do  not 
mean  that  depreciation  in  the  proper  sense  has  been  pro- 
vided for.  Depreciation  is  the  larger  conception  of  general 
loss  of  value  rather  than  that  of  special  and  minor  injury 
due  to  use. 

*' Writing  Down'*  not  always  Satisfactory. 

While,  as  we  have  seen,  the  process  of  writing  down 
assets  is  truthful  and  (if  correctly  done)  gives  a  sound 
and  accurate  idea  of  the  exact  status  of  the  business  at 
the  end  of  the  fiscal  period,  it  is  not  always  satisfactory. 
One  objection  to  ** writing  down"  the  assets  is  that  the 
original  cost  and  the  full  extent  of  provision  for  depre- 
ciation during  the  life  of  the  assets  is  not  readily  ascer- 
tained from  the  accounts.  Moreover,  the  process 
does  not  tell  what  has  been  done  with  the  cash  repre- 
senting the  reduction  in  assets,  although  a  study  of  the  ac- 
counts will  reveal  where  such  cash  has  gone.  Moreover, 
the  direct  expenditure  of  funds  thus  set  apart  out  of 
profits  for  the  purpose  of  restoring  the  same  assets 
to  exactly  their  original  condition  is  not  always  possible. 
Thus  the  deterioration  of  the  building  which  we  supposed 
to  be  represented  by  $200  at  the  end  of  the  first  year  may 
be  due  simply  to  the  wearing  off  of  paint,  etc.,  the  indica- 
tions being  that  in  the  course  of  another  year  a  complete 
renovation  would  cost  $400,  which  is  at  the  rate  of  $200 
per  annum,  even  though  it  may  not  be  deemed  wise  to  make 
any  direct  expenditure  on  the  building  at  the  time.     In 


THE  PRINCIPLES  OF  ACCOUNTINa  91 

the  same  way,  the  horses  owned  by  the  concern  are  grow- 
ing older  year  by  year  and  are  losing  value  to  that  extent, 
but  they  will  continue  serviceable  for  a  number  of  years 
and  the  amount  of  their  deterioration  per  annum  is  not 
sufficient  to  buy  a  new  horse.  The  difficulty  of  apportion- 
ing depreciation  and  of  putting  back  exactly  the  same  qual- 
ity and  value  of  assets  as  have  been  destroyed  by  use, 
becomes  greater  and  greater  as  the  business  becomes  more 
and  more  complex.  While,  therefore,  the  process  of  writ- 
ing down  the  assets  to  correspond  with  their  true  value 
is  useful  and  necessary,  it  alone  does  not  supply  an 
adequate  and  complete  accounting  for  the  change  that  has 
taken  place  in  the  nature  of  the  firm's  assets.  What  can 
be  done  to  complete  this  accounting?  In  the  analysis  al- 
ready made,  it  was  assumed  that  an  entry  is  made  on  the 
credit  side  of  the  fixed  plant  and  property  accounts,  this  en- 
try giving  rise  to  a  corresponding  debit  entry  in  profit  and 
loss,,  indicating  a  loss  of  that  amount.  Instead  of  proceed- 
ing in  this  manner  the  accounting  may  be  carried  on  as 
follows :  After  making  the  proper  credit  entry  in  the  fixed 
plant  and  property  accounts  just  as  before,  a  "deprecia- 
tion account"  may  be  raised  and,  instead  of  carrying  the 
corresponding  debit  entry  to  profit  and  loss,  it  may  be  en- 
tered in  this  depreciation  account.  The  entry  may  be  made 
as  a  lump  sum  representing  the  estimated  total  deprecia- 
tion which  has  been  spread  out  over  the  real  estate,  horses 
and  wagons  and  other  accounts,  in  which  case  the  account 
would  stand  somewhat  as  follows : 

DEPRECIATION, 
Dt.  <^r. 


Dec.  31  j  Wastage  of  assets  for 

I     past  year  [$450 


All  this  amounts  to  is  that  instead  of  entering  the  total 
loss  of  assets  as  a  loss  in  profit  and  loss  account  it  is  now 
entered  as  depreciation.  In  order  to  close  depreciation 
account,  if  nothing  further  is  done  the  balance  will  have 


92  HENRY  PARKER  WILLIS 

to  be  transferred  ultimately  to  the  debit  side  of  profit  and 
loss  and  thus  the  same  result  will  be  arrived  at  as  before. 
Depreciation  account  is  here  a  section  or  subdivision  of 
profit  and  loss.  Suppose,  however,  that  the  concern,  not 
thinking  it  desirable  to  retain  the  cash  idle,  or  to  divide  it 
among  the  stockholders,  or  to  reinvest  it  either  on  the  fixed 
assets  or  in  increasing  the  floating  assets,  determines  to 
invest  it  as  a  special  fund  to  be  drawn  upon  in  the  future. 
Suppose  it  is  decided  to  buy  bonds  with  the  amount.  An 
entry  is  made  in  cash  account  to  show  that  cash  has  been 
parted  with  in  order  to  pay  for  these  bonds.  This  will 
be  a  credit  entry  in  cash  somewhat  as  follows:    *'Dec.  31, 

By  cash  for  investment  bonds $450."    The  concern, 

however,  in  the  course  of  this  transaction  has  acquired 
bonds,  hence  a  bond  account  called  perhaps  "Depreciation 
Fund"  must  be  opened  to  represent  the  accession  of  assets 
mth  a  debit  entry  as  follows:  "Dec.  31,  To  U.  S.  bonds. . 
$450,"  it  being  assumed  that  the  United  States  bonds  are 
the  class  of  securities  in  which  investment  has  been  made. 
What  has  now  been  done  has  been  to  show  the  existence 
of  a  depreciation  of  specified  amount,  to  indicate  the  fact 
that  cash  has  been  disbursed  for  the  purpose  of  offsetting 
such  depreciation  and  finally  to  show  that,  in  this  process 
of  disbursing  cash,  sundry  assets  have  been  acquired  which 
have  taken  a  special  form — that  of  bonds.  It  will  be  noted 
that  according  to  this  method  the  depreciation  is  not  a  nec- 
essary charge  against  income  of  a  definite  period,  but  a 
charge  against  such  surplus  as  the  concern  may  accumulate. 
This  may  be  an  important  consideration  in  connection  with 
some  phases  of  cost  accounting,  as  will  later  appear. 

Depreciation  Reserve. 

It  may,  however,  be  impossible  to  spread  depreciation 
accurately  and  minutely  over  the  whole  of  the  plant  in 
all  of  its  details,  and  the  concern  may  not  want  to  attempt 
a  process  which  will  necessarily  be  inaccurate  in  some  de- 


THE  PRINCIPLES  OF  ACCOUNTINa  93 

gree.  If  that  be  tlie  case  it  may  be  considered  wise  simply 
to  set  aside  a  certain  sum  for  the  purpose  of  providing 
a  fund  out  of  which  to  meet  depreciation  when  such  de- 
preciation is  recognized  in  the  future  or  when  it  has  gone 
to  such  a  point  that  it  can  be  accurately  measured.  In 
this  case  the  concern  may  simply  determine  to  lay  aside 
a  more  or  less  arbitrary  sum  out  of  profits  with  which  to 
meet  possible  future  depreciation.  We  may  assume  that 
at  the  end  of  the  year  an  expert  man  goes  through  the 
plant  and  comes  to  the  conclusion  that  the  probable  annual 
depreciation  will  be  about  $450,  although  he  feels  uncer- 
tain as  to  precisely  how  much  should  be  assigned,  say,  to 
plant  or  fixtures.  Some  of  the  considerations  affecting 
his  judgment  will  be  sketched  later.  At  this  point  it  may 
be  assumed  that  his  judgment  is  taken  as  sufficiently  ac- 
curate. The  concern  determines  therefore  to  set  aside 
$450  out  of  the  gross  indicated  profits.  This  will  be  done 
by  making  a  debit  entry  in  profit  and  loss  after  gross 
profit  has  been  ascertained  while  a  corresponding  credit 
is  entered  in  a  new  ledger  account  called  ''Reserve  Fund" 
or  ''Surplus."  This  sum  may  be  disposed  of  in  any  way 
that  the  concern  decides  to  be  desirable.  If  it  now  follows 
the  same  policy  as  before  and  invests  in  bonds,  it  of  course 
draws  on  cash  to  that  extent,  thus  crediting  cash.  A 
bond  account  will  be  opened  and  will  be  debited  for  the 
amount  spent  for  the  bonds.  The  reserve  and  bond  ac- 
counts are  now  open  and  the  credit  entry  in  the  one  is  the 
same  as  the  debit  entry  in  the  other.  The  reserve  is  prac- 
tically a  part  of  capital  account,  it  being  a  sum  retained 
in  the  business  while  the  bond  account  with  its  debit  entry 
merely  means  that  capital  assets  have  been  invested  to 
that  extent  in  bonds.  If  at  some  time  in  the  future  it 
is  ascertained  what  depreciation  has  occurred,  the  assets 
are  written  down  to  that  extent  and  a  corresponding  debit 
entry  is  made  In  reserve,  reducing  it  by  a  similar  amount. 
The  concern  has  the  bonds  among  its  assets  and  they  will 


94  HENRY  PARKER  WILLIS 

appear  as  such.  If,  liowcver,  it  is  desired  to  restore  the 
assets  to  their  original  condition  by  drawing  on  the  re- 
serve, the  bonds  will  be  sold  in  whole  or  in  part  and  bond 
account  will  be  credited  correspondingly.  The  cash  thus 
realized  will  of  course  be  debited  to  cash  and  when  spent 
in  repairing  or  replacing  the  assets  cash  wi'^  be  credited 
and  a  corresponding  debit  entry  in  the  assets  account  will 
be  made.  Meanwhile,  if  the  fixed  assets  have  not  been 
revalued,  or,  Avhat  is  the  same  thing,  if  depreciation  has 
not  occurred,  they  appear  at  their  original  value  and  the 
amount  carried  to  reserve  fund  is  simply  a  net  addition  to 
the  funds  invested  in  the  business.  If,  however,  it  has 
been  determined  simply  to  use  the  cash  on  hand  and  re- 
tained in  the  business  as  a  reserve  or  as  offsetting  depre- 
ciation, in  the  same  way  that  any  other  cash  would  be 
used,  the  concern  will  reduce  its  valuation  of  the  fixed  as- 
sets and  will  use  a  corresponding  amount  of  cash  in  buy- 
ing more  floating  assets.  Here  there  is  a  gradual  transfer 
of  fixed  assets  into  floating,  the  reduction  in  the  value 
of  the  fixed  assets  being  represented  by  the  process  of 
writing  off,  while  the  regular  accounts  with  the  floating 
assets  are  increased  to  correspond  to  outlays  of  cash  made 
for  the  purchase  of  further  items  of  property  for  use  in 
doing  business.  The  concern  knows  that  it  is  putting  back 
into  the  business  as  much  as  it  is  losing  from  the  business 
in  the  shape  of  wasted  assets,  and  it  is  satisfied  with  the 
fact  that  the  business  has  in  all  of  its  branches  the  same 
amount  of  value  that  it  originally  had,  even  though  this 
value  is  now  differently  distributed.* 

Choice  of  Methods. 

A  choice  between  these  different  methods  of  account- 
ing for  depreciation  cannot  be  arbitrarily  indicated  but 

*  What  has  been  said  of  the  treatment  of  depreciation  may  be  summarized 
by  quoting  from  Mr.  Cole  (Accounts,  page  89)  with  reference  to  the  way  in 
which  depreciation  may  appear  on  the  balance  sheet  (Cf.  our  own  section  on 
balance  sheets,  pp.  161.  fif.,  of  the  present  volume).  Mr.  Cole  remarks:  "Depre- 
cation fund  .  .  .  may  appear  on  the  balance  sheet  in  one  of  three  combina- 
tions:    (1)  among  assets  only — in  which  case  specific  property  is  set  aside  to 


THE  PRINCIPLES  OF  ACCOUNTINa  95 

must  depend  somewhat  on  the  kind  of  business  in  which 
the  problem  presents  itself  and  the  policy  which  it  is  de- 
sired to  follow  in  connection  with  the  business.  Theoreti- 
cally, the  simplest  way  of  dealing  with  the  matter  is  that 
of  setting  aside  a  given  sum  as  an  allowance  for  depre- 
ciation, the  nominal  assets  being  reduced  by  a  correspond- 
ing amount  and  all  payments  for  new  assets  being  made  out 
of  this  fund.  Practically,  the  ordinary  business  will  usually 
not  follow  this  plan  but  will  adopt  the  system  of  annually 
putting  into  various  forms  of  machinery  or  plant,  about 
the  amount  that  it  is  considered  the  assets  have  run  down 
each  year.  This  gives  rise  to  continued  debit  entries  either 
in  the  various  plant  and  machinery  accounts  or  in  a  better- 
ments and  improvements  account,  and  to  corresponding 
credit  entries  in  cash  account  which  pays  for  them.  If  the 
old  assets  are  reduced  in  value  by  revaluation,  such  reval- 
uation being  exhibited  through  credit  entries  representing 
the  wastage,  these  credit  entries  will  be  paralleled  by  debit 
entries  in  the  corresponding  machinery  or  assets  accounts. 
If  the  wastage  is  less  than  the  reinvestment,  the  surplus 
will  show  on  balance  sheet  as  an  increase  or.  If  more,  as 
a  reduction  of  assets.  The  cost  of  the  betterments  goes 
to  profit  and  loss  as  an  expense.  The  important  matter 
from  an  accounting  standpoint  is  that  the  value  of  the  cap- 
ital in  the  business  shall  be  maintained  and  so  represented. 
Changes  in  the  value  of  particular  assets  representing  the 
capital  are  of  secondary  importance. 

It  will  be  necessary  to  deal  further  with  this  matter 
of  depreciation  when  we  come  to  speak  of  the  question 
of  balance  sheets.  From  what  has  been  said  it  is  clear 
that  the  goods  account  involves  a  set  of  entirely  new  and 

replace  or  repair  machinery,  or  buildings,  or  whatnot,  that  are  thought  to 
have  suffered  actual  depreciation;  (2)  among  both  assets  and  liabilities — in 
which  case  specific  property  is  set  aside  from  net  income  as  a  safety  fund  for 
possible  depreciation  not  thought  to  be  actual;  (3)  among  liabilities  onlj^ — 
in  which  case  the  amount  is  deducted  from  net  income  and  shown  on  the  books 
as  a  safety  fund  for  replacement  purposes,  but  the  actual  property  is  left 
among  the  general  assets  without  specific  designation.  In  the  first  case,  the 
fund  could  not  be  distributed  to  stockholders  without  impairing  capital;  in 
the  other  two  cases,  the  policy  might  be  changed  and  the  fund  distributed." 


96  HENRY  PARKER  WILLIS 

important  problems  as  soon  as  the  '^goods''  bought  by  the 
concern  are  of  a  fixed  character  which  may  depreciate  or 
increase  in  value. 

Causes  of  Deterioration. 

It  is  worth  while  in  this  connection  to  consider  just 
what  causes  give  rise  to  loss  of  value  and  may  therefore 
be  studied  by  the  business  concern  which  desires  to  make 
up  its  mind  regarding  the  probability  of  depreciation  as 
a  factor  in  its  doings  and  to  reach  a  decision  as  to  the  de- 
gree of  necessity  for  a  distinct  and  specific  provision 
against  loss.  Neglect  of  them  has  sometimes  thro\\Ti  a 
business  into  an  embarrassed  position  because  of  failure 
to  provide  for  a  contingency  which  was  considered  remote 
and  for  which  therefore  no  distinct  provision  was  made. 
The  main  causes  of  deterioration  are  as  follows:  (1)  The 
consumption  of  items  of  capital  during  a  period  of  produc- 
tion. An  examiple  of  this  sort  is  seen  in  the  case  of  tools 
which  are  worn  out  in  manufacturing  processes.  (2) 
The  reduction  of  the  value  of  privileges  and  rights.  An 
example  of  this  sort  is  seen  in  the  case  of  a  patent  which 
runs  for  a  definite  period  and  whose  value  is  therefore 
reduced  each  year  as  the  length  of  its  life  grows  shorter. 
A  lease  paid  for  in  a  lump  sum  at  the  beginning  is  another 
illustration  of  the  same  kind.  (3)  ''Wear  and  tear.''  This 
is  simply  the  natural  reduction  in  efficiency  or  durability 
which  objects  of  material  character  undergo  as  a  result 
of  use.  (4)  General  exhaustion  of  efficiency  as  seen  in 
the  decreasing  usefulness  of  an  object  in  connection  with 
the  service  for  which  it  was  intended  notwithstanding  it 
shows  no  perceptible  wearing  out.  Certain  electrical  ap- 
paratus illustrates  this  obsolescence.  (5)  Improve- 
ments tending  to  reduce  the  value  of  given  capital  or  ma- 
chinery. This  is  seen  in  cases  where  a  given  sum  has 
been  invested  in  a  material  object,  say  type  for  printing 
w^hich  is  then  rendered  obsolete  by  the  appearance  of  some 
mechanical  device  that  supersedes  it,  as,  for  instance,  the 


THE  PRINCIPLES  OP  ACCOUNTINa  97 

typesetting  maeliine,  wMcli  dispenses  with  the  use  of  mov- 
able types  and  substitutes  type  directly  east  in  a  mold 
in  the  machine.  (6)  Reduction  in  labor  or  material  costs 
where  contract  has  already  been  made  for  a  given  amount 
of  labor  or  material  at  a  price  which  holds  the  concern 
to  the  use  of  a  more  expensive  method  of  production.  It 
should  be  noted,  however,  that  business  losses  directly  and 
unmistakably  due  to  mistaken  policy  or  bad  judgment  can- 
not properly  be  charged  as  ''depreciation."  Depreciation 
relates  to  assets  as  such,  whether  they  be  tangible  or  in- 
tangible. Provision  against  business  losses  as  such  is  prop- 
erly called  "contingent  reserve"  and  is  part  of  surplus. 
But  in  whatever  way  deterioration  may  occur,  it  consti- 
tutes a  final  source  of  business  loss  and  in  most  cases 
cannot  be  definitely  counted  on  in  advance.  The  object  of 
allowing  for  depreciation  is  thus  not  merely  one  of  ac- 
counting, but  is  also  one  of  business  policy.  The  business 
firm  which  does  not  make  any  allowance  for  depreciation 
is  putting  itself  in  a  hazardous  position  from  which  it  may 
have  great  difficulty  in  emerging,  owing  to  the  sudden  oc- 
currence of  depreciation  which  makes  it  necessary  for  it 
to  change  the  machinery  already  installed  or  to  incur  other 
expense  without  having  made  any  allowance  in  advance 
for  resources  with  which  to  carry  out  an  expensive  under- 
taking of  this  description.  In  such  a  case  the  concern  is 
obliged  either  to  borrow  funds,  thereby  creating  an  addi- 
tional capital  liability,  or  else  to  recognize  a  reduction  in 
the  nominal  value  of  its  capital,  thereby  recapitalizing  on 
a  lower  basis,  or  else  to  get  the  funds  out  of  money  that 
would  otherwise  have  gone  for  dividends,  thereby  suspend- 
ing its  dividends  or  reducing  them. 

Estimating  Depreciation. 

In  the  illustrative  cases  already  given,  it  has  been  as- 
sumed that  depreciation  could  be  more  or  less  accurately 
estimated.  Thus  we  suppose  that  Smith  &  Brown  had 
no  trouble  in  engaging  an  expert  to  go  through  their  es- 

B— VIII— 7 


98  HENRY  PARKER  WILLIS 

tablisliment  and  inform  them  tolerably  accurately  how 
much  shrinkage  there  had  been  in  the  value  of  the  assets. 
It  was  supposed  that  the  amount  stated  by  the  expert  was 
accepted  without  question  and  the  accounting  was  based 
on  it.  Neither  of  these  things  is  strictly  true  in  practice. 
It  is  difficult  to  estimate  the  exact  amount  of  depreciation 
and  there  are  serious  mathematical  and  accounting  prob- 
lems connected  with  the  actual  recording  of  it.  In  esti- 
mating depreciation  several  factors  have  to  be  considered. 
These  are  as  follows;  (1)  The  original  cost  or  estimated 
value  of  the  asset;  (2)  the  estimated  life  of  this  asset;  (3) 
the  amount  expended  on  its  maintenance;  (4)  the  residual 
value  of  the  asset  after  a  given  period  of  time;  (5)  the 
choice  of  a  method  of  computing  depreciation  either  as  a 
fixed  percentage  of  the  total  original  value  of  the  asset 
or  as  a  percentage  of  its  regular  reduced  annual  value. 
Some  explanation  of  these  factors  may  be  desirable.  It 
is  easy  to  see  why  the  basic  factor  in  computing  depre- 
ciation is  the  original  or  estimated  value  of  the  asset.  This 
original  or  estimated  value  shows  how  much  has  actually 
gone  into  the  asset  from  the  firm's  funds  or  capital.  The 
length  of  its  estimated  life  gives  the  presumed  term  over 
which  the  depreciation  will  continue.  For  instance,  if 
Smith  &  Brown  found  it  necessary  to  rent  an  adjoining 
building  and  took  the  building  on  a  ten  years'  lease,  pay- 
ing the  owner  a  lump  sum  of,  say,  $1,000  down,  it  is  clear 
that  this  right  or  title  to  the  use  of  the  building  would  be 
one  of  their  assets  and  a  lease  account  would  at  once  be 
raised  and  debited  with  the  amount.  Now  if  $100  was 
written  off  each  year  from  the  value  of  this  lease  in  ten 
years  the  w^orth  of  the  asset  would  have  been  reduced  to 
zero  and  each  jear  this  lease  account  would  have  shown 
a  balance  of  $100  less  on  the  debit  side  while  profit  and 
loss  would  have  been  debited  with  an  equal  amount,  the 
annual  reduction  in  the  value  of  the  lease  appearing  each 
and  every  year  as  a  loss  or  expense  to  the  business.  It 
is  also  plain  that  this  would  be  a  rather  rough  way  of 


THE  PRINCIPLES  OF  ACCOUNTINa  99 

getting  at  the  facts  in  the  case  inasmuch  as  the  concern 
would  have  had  $1,000  tied  up  in  the  lease  for  the  first 
year,  $900  for  the  second  year,  $800  for  the  third  year, 
and  so  on,  so  that  the  cost  of  carrying  the  building  lease 
would  really  have  been  $100,  plus  interest  on  the  $1,000, 
the  first  year,  less  than  that  the  second  year,  and 
still  less  the  third  year.  It  would  have  been  pos- 
sible to  give  an  accurate  statement  of  the  actual 
depreciation  of  the  A^alue  of  the  lease  only  by  as- 
certaining the  exact  sacrifice  due  to  the  loss  of  one  year 
of  the  life  of  the  lease  (which  would  have  been  constant 
throughout)  and  the  sacrifice  during  the  first  year  due  to 
the  tying  up  of  $1,000.  Then  in  the  second  year  the  loss 
due  to  the  expiry  of  a  year  would  have  been  the  same 
while  the  sacrifice  of  capital  involved  would  have  been 
smaller.  All  this  would  have  involved  a  somewhat  elab- 
orate computation  for  the  purpose  of  ascertaining  the  ex- 
act amount  of  sacrifice  due  to  the  passage  of  time. 
Another  phase  of  this  problem  of  estimating  deprecia- 
tion was  indicated  in  the  third  consideration  enumerated 
above,  where  the  amount  expended  on  the  maintenance  of 
the  asset  has  to  be  considered.  For  instance,  suppose  that 
a  concern  is  estimating  the  depreciation  on  an  auto- 
mobile. The  extent  of  this  depreciation  will  depend  con- 
siderably upon  the  amount  expended  in  maintenance.  If 
the  owner  is  inexperienced  and  takes  care  of  the  machine 
himself,  depreciation  may  be  very  rapid,  while  if  the  care 
of  the  machine  is  entrusted  to  an  experienced  engineer 
who  is  authorized  to  replace  parts  calling  for  a  change 
as  soon  as  they  show  unmistakable  signs  of  unfitness,  the 
depreciation  may  be  very  slow  indeed.  A  rough  way  of 
getting  at  depreciation  would  be  to  ascertain  the  original 
cost  of  the  asset,  fix  upon  a  definite  length  of  life  during 
which  it  will  probably  continue  to  be  used,  ascertain  from 
experience  the  annual  cost  of  maintaining  it  in  proper  con- 
dition, multiply  this  by  the  number  of  years  of  use,  add 
to  the  original  cost  of  the  machine,  regard  the  total  as 


100  HENRY  PARKER  WILLIS 

the  actual  sacrifice  involved  in  using  the  machine  for  the 
given  number  of  years,  compute  the  actual  annual  out- 
lay necessary  to  amount  at  the  end  of  a  number  of  years  to 
tills  aggregate  sacrifice,  and  have  that  amount  set  aside  as  a 
depreciation  fund  for  that  particular  asset  or  class  of  as- 
sets. Of  course  this  assumes  that  the  asset  is  worthless 
at  the  end  of  the  period.  This  would  be  true  of  such  in- 
tangible assets  as  patent  rights,  franchise  rights,  leases, 
etc.,  which  expire  in  the  course  of  time  but  it  would  not 
be  true  of  any  material  object  because  such  objects  would 
almost  invariably  have  what  is  called  a  ''residual  value." 
Thus  in  the  case  of  the  automobile  the  machine  when  en- 
tirely worn  out  and  worthless  for  further  use  as  an  auto- 
mobile would  have  some  value  as  scrap  steel,  old  rubber, 
etc.,  while  parts  of  it  might  have  a  substantial  value  for 
their  original  purpose.  In  such  cases  a  more  accurate  esti- 
mate of  depreciation  would  be  arrived  at  by  deducting 
the  estimated  residual  value  of  the  asset  from  the  total 
estimated  sacrifice  involved  in  getting  the  asset  and  main- 
taining it  throughout  its  natural  life.  It  is  observable, 
however,  that  in  all  such  cases  an  element  of  estimate 
which  grows  larger  and  larger  enters  into  the  computation. 
When  the  effort  is  made  to  allow  for  such  elements  of 
depreciation  as  those  which  grow  out  of  changes  in  prices 
of  stock  or  material  on  hand,  or  out  of  the  fact  that  new 
machinery  may  suddenly  be  rendered  obsolete  by  reason 
of  subsequent  inventions  which  make  it  possible  to  pro- 
duce more  cheaply,  the  process  of  estimating  depreciation 
is  purely  speculative,  and  depends  entirely  upon  the  ideas, 
judgment,  or  perhaps  fancy,  of  the  person  who  is  making 
the  estimate.  The  imprudent  man  will  take  his  chance 
that  no  such  unexpected  elements  of  depreciation  due  to 
unforeseen  contingencies  will  develop,  while  the  more 
cautious  business  man  will  set  aside  a  fund  designed  to 
meet  just  such  incidents.  The  use  of  some  depreciation 
policy  is,  however,  becoming  more  and  more  common  and 
is  quite  as  much  to  be  insisted  on  as  is  the  use  of  insurance 


THE  PRINCIPLES  OF  ACCOUNTINa         101 

policies.  In  fact  there  is  the  same  reason  for  the  one  as 
there  is  for  the  other.  In  allowing  for  depreciation,  the 
danger  to  be  guarded  against  is  that  of  overdoing  the  mat- 
ter and  making  allowances  for  something  which  in  the 
nature  of  the  case  cannot  be  allowed  for  or  which  is  offset 
by  an  element  of  appreciation  that  counteracts  the  loss 
due  to  the  wearing  out  of  assets.  It  is  possible  by  a  too 
cautious  depreciation  policy  unnecessarily  and  unreason- 
ably to  reduce  legitimate  dividends  and  thereby  to  deprive 
the  stockholders  of  returns  on  their  investments  which 
they  ought  to  have  and  which  if  made  would  keep  the  cred- 
it of  the  concern  with  its  stockholders  so  good  that  it  would 
have  no  trouble  in  raising  additional  capital  should  that  be 
wanted  in  the  future. 

Example  of  Insurance  Policy. 

An  example  of  the  conservative  application  of  a  policy 
of  safeguarding  capital  against  possible  loss  is  seen  in  the 
case  of  our  national  banking  law  which  has  been  construct- 
ed with  the  idea  of  protecting  creditors  and  incidentally 
stockholders  of  the  banks  organized  under  its  terms,  there- 
by giving  stability  to  the  institutions.  The  national  banking 
law  requires  that  a  bank  before  declaring  any  dividends 
shall  set  aside  a  surplus  equal  to  20  per  cent  of  its  capital. 
After  it  has  accumulated  this  amount,  it  is  at  liberty  to  be- 
gin declaring  dividends.  That  is  to  say,  a  bank  with  $100,- 
000  capital  earns  during  its  first  year  (let  us  suppose)  $10,- 
000.  Its  books,  in  other  words,  show  a  profit  of  $10,000. 
This  is  at  once  credited  to  a  surplus  account  and  the  sum  is 
then  used  in  the  business — that  is,  is  invested  in  stocks, 
bonds,  commercial  paper,  etc.  This  process  is  continued 
until  $20,000  is  shown  by  the  surplus  account.  After  that 
time  the  bank  can  declare  dividends  as  much  as  it  pleases 
so  that  it  does  not  infringe  on  its  capital  or  surplus.  Here 
we  have  a  case  where  the  possibility  of  depreciation  is 
recognized  and  a  fund  called  ''surplus"  is  set  aside  to  meet 
it.    If  bank  losses  occur  during  the  first  year  equal  to  $4,000, 


102  HENRY  PARKER  WILLIS 

there  is  only  $6,000  left  to  be  credited  to  surplus.  Most 
banks  carry  another  open  account  called  "undivided 
profits"  ^Yhich  is  credited  with  such  additional  values  as 
are  retained  in  the  business  over  and  above  the  value  of 
the  capital  and  surplus.  The  capital,  surplus  and  undi- 
vided profits  accounts  all  normall}^  show  credit  balances, 
and  the  surplus  and  undivided  profits  are  theoretically  in 
exactly  the  same  position  as  the  capital  account — they  rep- 
resent funds  that  have  been  put  into  the  business  and  for 
which  it  is  liable  to  the  stockholders. 

Appreciation. 

Some  reference  has  been  made  to  appreciation  in  con- 
nection with  the  discussion  of  depreciation.  The  subject, 
however,  is  not  one  that  needs  much  comment  because 
appreciation  is  not  a  danger  to  be  guarded  against  but  is 
merely  an  increase  in  the  value  of  assets  which  may  well 
be  recognized.  Suppose  that  Smith  &  Bro^\Ti's  build- 
ing increased  in  value  from  $2,000  to  $3,000,  owing  to  a 
natural  rise  in  the  worth  of  real  estate.  Smith  &  Brown 
would  simply  be  in  a  position  to  realize  $1,000  more  if 
their  business  went  into  liquidation.  If  they  had  a  regular 
revaluation  of  assets  it  would  appear,  however,  that  the' 
assets  were  now  worth  more  than  the  capital.  No  cash 
would  have  been  taken  in  but  the  valuation  at  which  the 
assets  stood  on  the  books  would  have  been  advanced  $1,000. 
That  is,  in  real  estate  account  there  would  appear  a  debit 
entry  **Dec.  31,  To  increased  value  of  building  on  revalua- 
tion  $1,000."    This  new  debit  item  should  give  rise 

to  a  new  account  which  might  be  entitled  ^'Reserve"  or 
'* Surplus"  and  in  which  there  would  be  a  credit  entrv 
somewhat  as  follows:  ''Dec.  31,  By  real  estate  .  .  $1,000." 
Here  what  is  tantamount  to  a  new  section  of  capital  ac- 
count would  have  been  created,  the  credit  balance  in  it 
representing  an  addition  to  capital  assets  in  the  form  of 
real  estate  and  showing  that  the  concern  was  liable  to  its 
stockholders  to  an  equal  amount,  just  as  in  the  case  of 


THE  PRINCIPLES  OF  ACCOUNTING         103 

capital  account.  It  should  be  noted,  however,  that  the 
dangers  of  overestimating  inherent  in  such  a  method  make 
many  regard  it  as  a  very  questionable  accounting  policy. 
Conservative  accountants  usually  hold  that  appreciation 
is  best  ascertained  by  actual  sale  and  that  otherwise,  only 
a  ''paper"  profit  will  result  which  is  not  available  as  divi- 
dends. Of  course,  artificially  ''writing  up"  a  surplus  re- 
serve with  such  a  "paper"  profit  does  not  show  real  con- 
ditions. Appreciation  can,  however,  often  be  recognized 
correctly,  as  in  the  case  of  quoted  securities. 

VIII.    MAOTJFACTUEING  ACCOUNTS. 
Special  Problem  of  Manufacturing. 

Thus  far  we  have  taken  it  for  granted  that  the  business 
operations  of  a  concern  are  of  a  single  more  or  less  uni- 
form kind.  In  the  case  of  the  retail  firm  whose  transac- 
tions were  set  forth  hypothetically,  it  was  stated  that  they 
were  the  buying  and  selling  of  goods.  Later  we  recog- 
nized the  necessity  in  many  businesses  of  investing  capital 
not  only  in  goods  but  in  fixed  forms  such  as  plant,  ma- 
chinery, tools,  etc.  Nothing,  however,  has  been  said  of 
those  cases  where  a  concern  is  engaged  in  two  or  more 
distinctly  different  kinds  of  operations.  The  grouping  of 
goods  account  as  between  various  departments — dry  goods, 
groceries  and  house-wares,  was  not  a  recognition  of  this 
fact,  because  the  business  operations  there  were  of  the 
same  kind — purchase  and  sale — although  they  dealt  with 
different  classes  of  goods.  A  concern  may,  however,  have 
more  than  one  distinct  kind  of  activity.  It  may  engage 
in  manufacturing  and  may  then  sell  the  products  of  its 
business.  It  may  be  a  transportation  company  and  at  the 
same  time  be  engaged  in  producing  articles  for  shipment, 
such  as  coal.  In  fact  there  may  be  various  combinations 
of  businesses  or  kinds  of  business  that  are  being  carried 
on  by  the  same  concern  or  under  substantially  identical 


104  HENRY  PARKER  WILLIS 

conditions.  In  such  cases,  there  is  the  same  reason  for 
segregating  the  operations  and  results  of  one  side  of  the 
business  from  those  of  another  that  is  recognized  in  the 
case  of  the  departmental  accounting  systems  of  which  we 
have  already  spoken.  The  necessity  for  such  segregation 
is,  however,  greater  in  the  latter  case  than  in  the  former 
because  of  the  fact  that  the  operations  are  different  in 
their  character,  involve  different  materials  and  methods, 
and  are  carried  on  by  individuals  of  different  classes  and 
abilities.  Not  only  for  the  purpose  of  showing  which  parts 
of  a  concern's  business  are  making  profits  and  which  ones 
are  incurring  losses,  but  also  for  that  of  showing  how  ex- 
tensive such  relative  profits  and  losses  are,  a  segregation 
of  accounts  is  desirable.  It  is  further  desirable  because 
of  the  fact  that  a  different  system  of  accounts  is  needed 
in  the  one  case  from  what  is  called  for  in  the  other.  To 
get  such  a  distinct  segregation,  implies,  however,  an  or- 
ganization of  the  business  for  that  purpose.  Such  an  or- 
ganization may  be  worked  out  in  any  one  of  several  dif- 
ferent w^ays.  In  order  to  illustrate  Avhat  is  meant  at  this 
point  we  may  assume  the  example  of  a  concern  which  is 
engaged  in  manufacturing  and  selling  shoes.  The  account- 
ing for  the  selling  end  of  the  business  will  naturally  be 
organized  on  an  independent  basis,  just  as  the  selling  de- 
partment is  probably  so  organized.  The  same  will  be  true 
of  the  manufacturing  end  which  is  undoubtedly  kept  sep- 
arate from  the  selling  end  in  organization,  and  should  be 
treated  in  the  same  wa}^  from  the  standpoint  of  account- 
ing. It  may  be  said  generally  that  there  should  be  a  sep- 
arate organization  and  a  separate  accounting  system  for 
each  separate  manufacturing  department  of  the  business 
and  that  these  separate  accounting  systems  should  fit  into 
one  general  system  which  is  calculated  to  combine  the 
results  of  the  whole  and  to  show  exactly  how  each  is  re- 
lated to,  w^hat  it  takes  from,  and  what  it  furnishes  to,  the 
general  business.    How  this  can  be  done,  particularly  with 


THE  PRINCIPLES  OF  ACCOUNTING         105 

reference  to  manufacturing,  presents  a  more  complex  prob- 
lem in  accounting  organization  than  any  thus  far  dis- 
cussed. 

Organization  of  Accounts. 

Starting  with  the  general  accounting  system  of  the  con- 
cern, we  may  suppose  that  business  is  opened  with  a  cash 
capital  all  paid  in  and  that  at  the  outset  it  is  determined 
to  recognize  three  distinct  departments  of  the  business — 
A,  B  and  C.  The  accounts  pertaining  to  capital,  cash,  etc., 
are  opened  in  the  usual  way  and  of  course  the  same  would 
be  true  of  the  plant  and  property  accounts  if  no  process 
of  segregation  was  attempted.  Just  here  is  the  first 
change  which  must  be  introduced  into  our  outline  of  or- 
ganization. In  a  former  illustration  (see  p.  80  foregoing) 
we  assumed  that  Smith  &  Brown  in  purchasing  a  stock 
of  goods  decided  to  put  these  goods  into  three  classes, 
groceries,  dry  goods  and  house-wares,  and  when  cash  was 
expended  after  crediting  the  cash  account,  instead  of 
debiting  a  general  goods  account  this  general  entry  in 
goods  was  broken  up  into  three  separate  items — one  for 
house- wares,  one  for  groceries,  and  one  for  dry  goods, 
which  we  supposed  to  be  $2,000  each.  It  will  be  recalled 
that  we  then  reopened  these  three  sections  of  goods  ac- 
count with  a  debit  entry  of  $2,000  in  each.  It  is  clear  that 
if  these  departments  had  been  sufficiently  different  from 
one  another — if,  for  example,  one  or  two  of  them  had  dealt 
with  manufacturing  and  one  had  been  a  retailing  process — 
it  might  have  been  desirable  to  make  a  distinct  segrega- 
tion of  this  same  kind  at  the  outset.  Thus,  if  the  three 
departments  A,  B,  and  C  spoken  of  are  conceived  to  be 
three  radically  distinct  branches  of  the  business,  a  sep- 
arate account  might  be  opened  with  each  and  might  bo 
debited  with  the  sum  total  set  apart  for  that  department 
out  of  the  capital  of  the  concern  which  we  assumed  to  be 
paid  up  in  cash.    This  is  w^hat  would  be  done  if  the  capital 


106  HENRY  PARKER  WILLIS 

set  apart  Avere  to  be  the  subject  of  bujdng  and  selling  in 
each  department,  it  being  consumed  in  the  course  of  the 
manufacturing  operation  just  as  goods  which  are  bought 
at  a  certain  price  and  are  sold  or  are  consumed  or  dis- 
pensed with,  so  far  as  the  business  itself  is  concerned,  in 
the  commercial  process.  In  manufacturing,  however,  a 
large  amount  of  fixed  capital  has  to  be  employed.  The 
concern  will  undoubtedly,  determine  at  the  outset  about 
how  this  fixed  capital  ought  to  be  distributed  or  appor- 
tioned among  the  several  departments.  It  will  then  per- 
mit the  investment  of  such  capital  in  the  machines,  plant 
and  property  pertaining  to  these  different  departments  ac- 
cording to  this  predetermined  proportion.  In  so  doing  it 
will  disburse  cash  which  will  be  simply  credited  to  cash 
account  and  debited  to  the  various  plant  and  property 
accounts  in  the  usual  way.  These  plant  and  property  ac- 
counts may  be  carried  in  the  general  ledger  just  as  before 
(see  p.  85  foregoing),  in  which  case,  so  far  as  we  have 
gone,  the  accounting  is  thoroughly  familiar.  If  the  busi- 
ness be  broken  up  into  three  departments  as  already  sup- 
posed, there  may  be  established  a  separate  ledger  for  each 
department  in  which  will  be  opened  the  various  plant  and 
property  accounts  represented  by  the  fixed  capital  per- 
taining to  that  department.  This  ledger  is  then  simply  a 
section  of  the  general  ledger.  The  accounts  are  kept  in 
a  separate  book  but  that  is  merely  for  the  sake  of  conven- 
ience and  they  might  just  as  well  be  in  the  general  ledger. 
If  distributed  by  departments  they  would  however  group 
together  the  accounts  pertaining  to  departments  A,  B,  and 
C,  so  far  as  the  investment  of  fixed  capital  was  concerned. 

Peculiarity  of  Manufacturing. 

It  is  now  possible  to  note  the  peculiarity  of  manufac- 
turing accounts.  A  plant  has  been  provided  and  every- 
thing made  ready  for  doing  certain  kinds  of  work.  The 
accounting  will  differ  from  ordinary  accounting  in  that 


THE  PRINCIPLES  OF  ACCOUNTING         107 

what  is  now  sought  to  trace  is  the  process  of  manufactur- 
ing and  its  eif  ect  on  the  general  business.  It  is  also  sought, 
where  there  is  a  departmental  organization,  to  trace  the 
relation  of  each  department  to  the  others.  Suppose  the 
process  of  production  now  begins.  It  gives  rise  to  outlays 
for  such  items  as  wages,  light,  fuel,  power,  etc.,  and  it 
also  results  in  using  up  raw  materials  and  in  to  some  ex- 
tent reducing  the  value  of  the  fixed  capital.  What  is  now 
to  be  attempted  is  to  show  how  these  changes  in  the  assets 
of  the  concern  are  represented.  Evidently  as,  say,  ma- 
terial is  used  up,  a  credit  must  be  given  to  material  ac- 
count. So  also  with  such  items  as  fuel  and  the  like.  These 
accounts  have  been  debited  when  the  fuel,  etc.,  was  bought. 
They  are  now  credited  as  the  same  items  are  used  up  or 
issued  for  consumption  in  the  business,  but  how  shall  the 
results  of  such  a  process  be  recorded?  The  next  step  in 
the  accounting  is  to  establish  the  corresponding  debit  en- 
tries. This  is  done  by  opening  accounts  corresponding  to 
each  of  those  already  existing.  Thus,  parallel  with  ma- 
terial account,  is  opened  a  ** material  issued"  account. 
Parallel  with  fuel  account  is  opened  a  ''fuel  issued"  account. 
Parallel  with  machinery  account  is  opened  a  "deprecia- 
tion" account.  All  these  accounts  are  debited  with  the 
same  amount  that  had  been  credited  in  the  accounts  origi- 
nally opened.  They  represent  the  plant,  stores,  material, 
etc.,  that  have  been  used  up.  In  other  words  they  are  the 
expense  side  of  manufacturing.  At  the  same  time,  as 
wages  are  paid,  the  money  will  be  debited  to  a  wages  ac- 
count and  any  other  expenses  that  are  incurred  will  be  deb- 
ited to  the  proper  expense  account.  We  now  have  a  set  of 
accounts  the  debit  entries  in  which,  as  already  stated,  rep- 
resent the  expense  side  of  manufacture.  We  can  now  open 
a  "manufacturing"  account  or  "production"  account.  To 
this  will  be  transferred  all  of  the  debit  entries  represented 
by  the  expense  items  which  have  been  described.  The 
account  will  be  credited  with  the  amount  of  product  turned 


108  HENRY  PARKER  WILLIS 

out.  At  what  price?  Evidently  if  the  operations  of  the 
month  resulted  in  1,000  pairs  of  shoes  and  if  we  were  to 
ascertain  from  the  credit  side  of  the  stores  or  materials, 
wages,  fuel,  etc.,  etc.,  accounts,  the  total  that  had  been 
disbursed  in  every  way  during  the  month,  we  should  know 
substantially  what  it  had  cost  us  to  turn  out  the  1,000  pairs 
of  shoes.  This  would  be  true  of  course  only  if  there  had 
been  no  waste  and  nothing  remained  unaccounted  for. 
But,  under  these  conditions,  we  might  at  the  end  of  the 
month  enter  the  1,000  pairs  of  shoes  in  the  production 
account  at  the  actual  outlay  value  as  shown  in  the  way 
just  indicated.  Then  if  the  department  turned  the  shoes 
over  to  Department  B  for  packing  and  shipment  it  would 
credit  the  production  account  with  1,000  pairs  of  shoes. 
At  what  price  ?  It  might  credit  the  account  with  the  shoes 
at  exactly  the  price  shown  by  the  debit  entries,  since  no 
profit  is  sought  to  be  made.  In  that  case  production  ac- 
count would  be  closed  without  a  balance.  What  would 
be  the  relation  between  this*set  of  accounts  and  the  gen- 
eral fiscal  accounting  conducted  in  the  general  ledger? 
The  debit  side  of  the  manufacturing  account  was  the  total 
which  was  distributed  through  the  various  investment  and 
expense  accounts  in  the  departmental  ledger  as  a  series 
of  credits  showing  outlays.  The  outcome  of  the  concern's 
operations  in  Department  A,  that  is,  the  1,000  pairs  of 
shoes  which  now  appear  on  the  credit  side  of  production 
account  as  having  been  disposed  of  by  transfer  to  Depart- 
ment B,  represents  what  the  department  has  given  to  the 
general  business  or  to  some  one  of  its  branches.  The 
credit  side  of  production  account,  which  shows  the  goods 
turned  over,  may  be  summarized  and  transferred  to  the 
credit  side  of  general  profit  and  loss  account  in  the  gen- 
eral ledger  or  to  a  special  section  of  profit  and  loss  designed 
to  show  the  results  of  operating  Department  A.  On  the 
debit  side  will  be  placed  a  summarized  statement  of  the  ex- 
penses.     For    the    sake    of   purely    theoretical    illustra- 


THE  PRINCIPLES  OF  ACCOUNTING         109 

tion,  assume  that  the  machinery,  tools,  etc.,  employed  by 
Department  A  were  of  so  simple  a  type  that  they  were 
wholly  used  up  during  the  first  month's  operations  and 
that  the  same  was  true  of  raw  material  and  every  other 
item.  Evidently  then  the  departmental  books  would  show 
on  the  debit  side  of  each  expense  account  the  amounts 
laid  out  for  various  things,  and  on  the  credit  side  the  totals 
of  these  things  used  up,  estimated  at  their  cost  value.  The 
manufacturing'  or  production  account  would  show  on  its 
debit  side  the  total  cost  value  of  the  product,  whatever 
it  was,  which  would  be  identical  with  the  totals  of  the 
debit  or  credit  entries  (indifferently)  in  all  of  the  expense 
or  outlay  accounts  taken  together.  The  credit  side  of 
production  account  would  show  a  total  of  exactly  the  same 
amount  representing  the  goods  turned  over  to  Department 
B.  If  everything  had  been  used  up  perfectly  evenly  in 
the  way  indicated  this  total  value  would  be  identical 
with  the  amount  that  had  been  laid  out  for  the  various 
materials  of  manufacture,  machinery,  wages,  etc.  Depart- 
ment A's  account  in  the  general  ledger  would  thus  show 
the  same  on  its  debit  as  on  its  credit  side  while  the  account 
of  Department  B  in  the  general  ledger  would  be  debited 
with  the  goods  it  had  received  from  Department  A  at  their 
cost  value. 

Teclinical  Profit  or  Loss. 

But  of  course  no  operation  in  actual  business  would 
work  out  evenly  in  this  way.  It  is  therefore  neces- 
sary to  alter  our  assumptions  somewhat  in  order  to  cor- 
respond more  closely  with  the  actual  facts  of  trade.  The 
first  important  modification  to  be  made  is  seen  in  the  fact 
that  it  is  not  possible  to  close  up  a  manufacturing  opera- 
tion evenly  at  the  end  of  a  fiscal  period.  Not  only  would 
the  machinery  be  still  on  hand  but  there  would  be  balances 
of  raw  materials,  perhaps  by-products,  etc.,  to  be  disposed 
of.    In  other  words,  it  would  not  be  possible  on  the  ac- 


110  HENRY  PARKER  WILLIS 

counting  basis  already  indicated  to  ascertain  the  precise 
cost  of  the  goods  turned  out.  That  is  to  say,  the  produc- 
tion account  could  not  be  debited  or  credited  with  the 
amount  of  goods  produced  at  their  values.  True  the  pro- 
duction account  could  be  debited  with  all  actual  outlays 
during  the  month  as  fast  as  these  w^ere  credited  to  the 
various  accounts  which  provided  for  them  and  then  the 
total  outlay  could  be  taken  as  the  value  of  the  goods  pro- 
duced which  would  appear  on  the  credit  side  when  the 
goods  were  transferred  to  some  other  department.  Prob- 
ably, however,  the  concern  would  prefer  to  assign  a  nom- 
inal value  ascertained  by  experience  to  the  product.  Sup- 
pose that  the  actual  cost  value  had  been  found  by  expe- 
rience to  run  about  $1  a  pair  for  shoes.  The  credit  entry 
in  the  production  account  would  then  be  $1,000,  this  being 
a  purely  nominal  figure  determined  on  for  the  purpose  of 
making  the  entry.  On  the  debit  side  of  production  account 
would  still  appear  the  actual  outlays  made  during  the 
month  and  on  the  credit  side  the  assumed  arbitrary  value 
of  the  shoes  at  $1  per  pair.  It  is  obvious  that  this  produc- 
tion account  could  be  closed  only  by  crediting  the  remain- 
ing values  of  materials  issued,  fuel  issued,  etc.  The  ac- 
count would  show  on  its  debit  side  the  amount  actually 
used  up  during  the  period  for  materials  and  actually 
laid  out  for  expenses  of  various  kinds,  and  on  the  credit 
side  the  amount  of  materials  on  hand,  the  amount  of  pay- 
ments made  for  future  expenses,  as,  for  example,  where 
machinery  was  rented  for  a  term  of  months  and  paid  for 
in  advance,  etc.  All  these  debit  items  would  be  debited 
to  production  account  because  they  would  be  received  by, 
or  put  into,  the  process  of  production  while  the  credit 
entries  would  show  the  goods  turned  over  to  other  depart- 
ments or  retained  on  hand  in  a  finished  or  incomplete  or 
unmanufactured  condition,  the  finished  goods  being  listed 
at  the  arbitrary  value  which  has  been  assigned  to  the  com- 
pleted goods  per  unit,  while  the  materials  are  listed  at 


THE  PRINCIPLES  OF  ACCOUNTINa         111 

the  cost  value.  Under  these  circumstances,  the  produc- 
tion account  would  show  an  excess  on  the  credit  side  if  the 
value  of  the  goods  produced  exceeded  cost,  while  it  would 
show  an  excess  on  the  debit  side  in  case  the  reverse  were 
true.  The  process  of  manufacturing  carried  on  in  Depart- 
ment A  would  thus  show  a  technical  profit  or  loss  when 
the  entries  were  transferred  to  the  profit  and  loss  account 
of  Department  A  in  the  general  ledger.  The  technical 
profit  or  loss  thus  made  .is  thereby  transferred  to  general 
profit  and  loss.  How  about  the  accounting  of  Department 
B  which  deals  with  the  packing  and  shipping*?  We  saw 
that  when  the  thousand  pairs  of  shoes  are  turned  out  they 
are  transferred  at  a  value  of  say  $1  per  pair  to  Department 
B.  This  of  course  means  that  the  account  of  Department 
B  in  the  general  ledger  must  be  debited  with  1,000  pairs 
of  shoes.  A  system  of  accounting  may  now  be  established 
for  Department  B  by  itself.  In  a  ledger  set  apart  for  the 
purpose  will  be  created  first  of  all  a  stock  account  which 
is  debited  with  the  value  of  the  goods  turned  over  by 
Department  A  or  $1,000.  Other  accounts  will  be  raised 
as  money  is  paid  out.  Thus,  for  example,  money  may  be 
disbursed  for  wages  and  gives  rise  to  a  wages  account 
which  is  debited  with  the  total  spent  for  that  purpose. 
There  may  be  charges  for  rent  which  will  be  debited  to 
rent  account;  for  material,  debited  to  material  account, 
and  for  various  other  things.  Of  course  the  sum  totals 
of  these  outlays  must  appear  on  the  debit  side  of  the  de- 
partmental production  account  conducted  for  Department 
B,  in  the  departmental  ledger.  As  materials  are  issued, 
material  account  is  credited  with  the  amount  of  material 
issued  for  various  purposes  and  so  on.  The  production  ac- 
count will  show  the  total  amount  spent  on  all  of  the  various 
expenses  of  production  and  on  its  credit  side  will  show  the 
value  of  the  goods  as  completed  and  turned  over  to  Depart- 
ment C.  We  started  with  the  assumption  that  Department 
B  took  over  shoes  valued  at  $1,000  from  Department  A. 


112  HENRY  PARKER  WILLIS 

During  the  process  of  preparing  for  the  market,  packing, 
etc.,  it  may  be  supposed  that  25  cents  in  cost  has  been  added 
to  each  pair  of  shoes.  This  means  then  that  the  department 
has  advanced  the  shoes  in  value  by  that  amount  and  that 
when  it  is  ready  to  turn  them  over  to  Department  C  for  sell- 
ing it  will  turn  over  shoes  worth  $1,250,  the  added  $250  be- 
ing the  increment  of  value  that  came  to  the  shoes  while  they 
were  passing  through  Department  B.  As  in  the  case  of 
Department  A  the  debit  entries  in  the  production  account 
are  identical  with  the  credit  entries  which  are  made  from 
time  to  time  in  the  various  expense  and  plant  accounts. 
If  the  manufacturing  process  worked  out  evenly,  wear- 
ing out  all  the  machinery,  using  up  all  the  raw  material, 
etc.,  in  the  course  of  the  fiscal  period,  the  total  credit  en- 
tries in  all  of  these  accounts  would  equal  the  total  debits 
made  in  them  to  start  with,  thus  balancing,  while  the  total 
debit  entries  in  production  account  would  simply  rep- 
resent the  sum  that  would  have  to  be  entered  on  the  credit 
side  of  production  account  when  the  goods  were  trans- 
ferred to  Department  C  for  sale.  The  same  remarks  that 
hold  good  of  the  accounting  for  Department  A  hold  good 
also  of  the  accounting  for  Department  B.  If,  as  in  our 
latest  assumption,  the  entered  value  of  the  goods  on  the 
credit  side  of  the  production  account  is  taken  as  an  arbi- 
trary value  or  *Hrade  value,"  then  the  department  may 
show  a  technical  profit  or  loss.  That  is,  before  the  excess 
value  of  the  completed  goods  recorded  at  this  trade  value 
is  transferred  to  the  credit  side  of  the  profit  and  loss  ac- 
count of  Department  B  in  the  general  ledger,  the  debit 
side  of  Department  B  is  fully  written  up  and  closed  by 
including  therein  all  elements  of  outlay,  while  the  credit 
side  is  likewise  fully  written  up  by  including  finished  prod- 
uct, material,  etc.,  still  on  hand  but  not  transferred,  so 
that  it  may  show  a  technical  profit  owing  to  the  use  of 
an  arbitrary  or  trade  value  for  the  use  of  the  goods  as 
turned  out.    In  that  case  of  course  the  technical  profit  is 


THE  PRINCIPLES  OF  ACCOUNTINa         113 

transferred  to  general  profit  and  loss  account.    The  same 
is  done  if  a  loss  is  shown. 

Selling  the  Goods. 

We  are  now  ready  for  the  selling  of  the  goods.  Depart- 
ment C  takes  them  over  and  they  of  course  consti- 
tute a  debit  in  its  departmental  stock  account  in  the 
departmental  ledger.  In  Department  C's  ledger  the 
stock  account  is  opened  as  soon  as  the  department 
begins  to  take  over  goods  from  other  departments. 
Credit  entries  will  be  made  in  this  account  as  the 
goods  in  stock  are  drawn  off  for  sale  to  the  public. 
Of  course  other  accounts  will  be  entered  in  this  led- 
ger. There  will  necessarily  be  a  wages  account  and  a  rent 
account,  for  the  use  of  the  premises  used  as  sales  rooms, 
which  is  debited  with  the  outlay  for  rent.  Expenditures  for 
advertising  will  be  debited  to  an  advertising  account  which 
will  be  written  up  from  some  record  showing  the  space  used 
in  various  advertising  media.  An  account  corresponding  to 
the  production  account  but  which  may  be  called  sales  ac- 
count will  be  raised.  The  entries  on  the  debit  side  of  this 
sales  account  will  be  all  of  the  credit  entries  that  have 
been  made  in  the  various  outlay  accounts  as  rent,  wages, 
advertising,  etc.,  etc.  On  the  credit  side  will  appear  the 
actual  cash  values  of  the  goods  as  they  are  parted  with. 
We  may  now  turn  to  the  general  ledger  once  more.  On 
the  debit  side  of  Department  C's  accounts  have  been 
entered  the  actual  total  cash  outlays  as  they  have  been 
made  in  behalf  of  Department  C.  These  outlays  have  of 
course  given  rise  to  corresponding  credits  in  general  cash 
account  as  the  money  was  parted  with.  The  credit  side 
of  Department  C's  departmental  account  can  be  written  up 
from  day  to  day,  week  to  week,  or  month  to  month  as  is  de- 
sired. The  credit  entries  are  the  goods  which  have  been 
supplied  by  Department  C  to  the  general  public,  that  is  to 
say,  which  have  been  parted  with  by  it.  The  account  is 
completed  and  balanced  in  exactly  the  same  way  as  those  of 


B— VIII— 8 


114  HENRY  PARKER  WILLIS 

Departments  A  and  B.  Here  however  is  an  additional 
problem.  The  goods  parted  with  by  Department  C  are  not 
turned  over  to  another  department  as  was  done  by  De- 
partments A  and  B  but  are  sold  to  the  outside  public  which 
paj^s  for  them  in  cash  or  gets  them  on  credit.  As  fast 
therefore  as  credit  entries  are  made  in  Department  C's 
dejDartmental  sales  account  in  its  departmental  ledger,  cor- 
responding entries  are  made  on  the  debit  side  of  general 
cash  or  bank  account  because  cash  has  been  received  or 
checks  deposited  as  they  have  come  in  from  the  general 
public  in  pajTuent  for  the  goods.  If  the  public  has  not 
paid  in  cash  or  checks  but  has  obtained  the  goods  on 
credit,  personal  accounts  are  opened.  These  belong  to 
the  general  ledger  and  not  to  the  accounting  system  of 
Department  C.  Department  C  deals  only  with  the  opera- 
tion of  selling.  The  general  accounting  system  takes 
charge  of  what  is  obtained  from  this  operation  of  sell- 
ing whether  it  be  cash,  bank  credits  or  claims  against  indi- 
viduals. It  is  clear  that  the  departmental  sales  account 
of  Department  C  wdll,  if  the  business  has  been  success- 
fully carried  on,  show  a  balance  on  the  credit  side  which 
is  transferred  to  profit  and  loss  as  a  profit.  It  has  been 
preceded  there  by  the  profits  shown  by  Departments  A 
and  B  which  were  described  as  ''technical."  They  were 
*' technical"  simply  because  they  were  made  at  the  expense 
of  the  business  itself.  That  is  to  say  if  Departments  A 
and  B  had  turned  their  output  over  to  C  at  exact  cost  as 
measured  by  outlay  the  whole  profit  would  have  been  made 
by  Department  C  and  would  have  been  equal  to  the  dif- 
ference between  the  final  cost  of  the  goods  and  the  amount 
finally  realized  for  them.  The  profit  made  by  Depart- 
ment C  is  smaller,  in  proportion  as  technical  profits  have 
been  made  by  A  and  B,  but  inasmuch  as  these  elements 
of  profit  are  aU  united  on  the  credit  side  of  profit  and 
loss  in  the  general  ledger  the  result  so  far  as  the  general 
business  is  concerned  is  the  same.    The  results  of  the  ac- 


THE  PRINCIPLES  OF  ACCOU'NTING 


115 


counting  as  shown  in  tlie  manufacturing  and  trading  ac- 
counts and  through  them  in  profit  and  loss  are  illustrated^ 
below. 

Manufacturing  Account. 
DEPARTMENT  A. 


June  30 


To  cost  of  material 
Stock  Jan.  1. 
Purchases  to 
June  1 


To  wages' 
"    rent,  taxes,  etc. 
"    depreciation 
"    sundries 


June  30 


By  stock  on  hand 


By  value  of  product  at 
cost  of  manufacture 


Manufacturing  Account  (Packing). 
DEPARTMENT  B. 


June  30 


To  goods  at  cost  of 
manufacture,  Dept.  A 


To  wages 
"    rent,  taxes,  etc. 
"    depreciation 
"      sundries 


June  30    By  value  of  product  at 
cost  of  manufacture 


Trading  Account. 
DEPARTMENT  C. 


June  30 


To  goods  at  cost  of 
manufacture,  Dept. 
"    salaries 
"    commissions 
"    discounts 

To  profit  and  loss  % 
Gross  profit 


June  30     By  sales 


116 


HENRY  PARKER  WILLIS 


PROFIT  AND  LOSS. 
(General  Ledger.) 


June  30 


To  rent 
"    salaries 
"    office  expenses 
"    allowance  for 
bad  debts 
"    interest 
"    dividend 
"    reserve  fund 
"    balance 


June  30 


By  gross  profit, 

manf  g  account  A* 
"    gross   profit, 

manf'g  account  B* 
"    gross  profit 

trading  account  C 
"    discounts,  etc. 


Contents  of  General  Ledger. 

What  is  left  under  these  conditions  for  the  general 
ledger?  We  had  the  capital  and  cash  accounts  to  start 
with,  bank  account  and  the  like.  There  will  also  be  the 
departmental  profit  and  loss  accounts  which  gather  the 
results  of  A,  B  and  C.  The  relation  of  the  several  produc- 
tion accounts  or  manufacturing  accounts  or  sales  or  trad- 
ing accounts  found  in  the  several  departments  and  carried 
by  each  in  its  special  ledger  (or  if  the  bookkeeping  is  all 
done  in  one  ledger,  then  in  the  general  ledger),  is  thus 
obvious.  These  accounts  are  ultimately  of  the  same  kind 
that  were  studied  in  connection  with  the  trading  account  of 
retail  business.  They  are  accounts  showing  gross  results 
of  business  operations,  that  is  to  say,  they  supply  the  in- 
formation for  the  preparation  of  profit  and  loss  account. 
They  have  grouped  on  their  respective  debit  sides  the 
current  special  expenses  incurred  in  manufacturing  and 
on  their  respective  credit  sides  the  income  from  manufac- 
turing, packing,  selling,  or  whatnot,  or  they  may  merely 
show  the  balances  drawn  from  the  several  departmental 
ledgers.  They  thus  furnish  when  summarized  the  ma- 
terials for  a  final  profit  and  loss  account  or  at  least  for 
preliminary  work  toward  such  a  profit  and  loss  account. 
As  a  result  of  the  working  out  of  these  trading  accounts 
it  would  be  possible  to  carry  to  profit  and  loss,  statements 

*  In    this    case    n'O    entry    because  these  were  carried  at  cost  of  manu- 
facture. 


THE  PRINCIPLES  OF  ACCOUNTINa         117 

showing  the  expenses  of  manufacture  incurred  in  Depart- 
ment A  and  the  value  of  product  turned  out  in  Department 
A,  while  the  same  is  done  for  Department  B  and  in  the 
case  of  Department  C  in  our  illustration  the  expenses 
show  on  the  debit  side  while  the  income  from  sales  shows 
on  the  credit  side,  such  income  having  of  course  been 
debited,  as  received,  to  general  cash  account.  In  the  gen- 
eral ledger,  also,  will  be  found  the  personal  accounts  of 
those  individuals  who  have  had  dealings  with  the  firm  by 
taking  its  finished  product.  If  instead  of  paying  cash  for 
machinery,  supplies,  etc.,  for  the  several  departments 
these  items  were  obtained  on  credit,  there  would  be  per- 
sonal accounts  with  the  individuals  who  supplied  them. 
Beside  these  there  will  be  accounts  with  all  those  expenses 
which  are  not  capable  of  analysis  and  distribution  to  the 
several  departments.  An  example  of  such  expenses  might 
be  found  in  the  case  of  the  salary  of  the  president  of  the 
concern.  If  it  were  deemed  possible  to  apportion  this 
salary  in  equal  amounts  to  the  different  departments,  it 
might  when  paid  be  entered  as  a  debit  in  due  proportion 
to  the  departmental  accounts.  This  would  of  course  give 
rise  to  a  corresponding  entry  either  in  the  wages  account 
of  the  department  (debit)  or  a  debit  entry  in  some  ac- 
count specially  raised  for  the  purpose,  as,  for  example, 
''managerial  expenses."  It  is  much  more  likely  that  the 
concern  will  prefer  to  retain  this  and  other  outlays  that 
are  not  easily  apportioned,  such  as  interest  on  bonds,  etc., 
in  accounts  in  the  general  ledger  which  represent  non- 
apportionable  outlays  and  which  therefore  go  to  make  up 
the  debit  side  of  general  profit  and  loss.  That  is  to  say, 
they  act  as  deductions  from  the  gross  profits  reported  by 
the  three  departments  of  the  concern  and  when  they  have 
been  offset  against  these  gross  profits  the  result  is  the  net 
profit  of  the  business  which  presumably  is  available  for 
dividends.  Wliat  has  been  gained  by  this  scheme  of  analyz- 
ing the  accounts  as  has  been  done?    Merely  the  arrange- 


lia  HENRY  PARKER  WILLIS 

ment  of  outlays  by  departments  or  processes  so  as  to  show 
the  position  of  the  business  at  various  stages  in  its  de- 
velopment. The  system  of  accounting  thus  indicated 
furnishes  a  cross  section,  so  to  speak,  of  the  business  at 
any  point  that  is  desired.  It  shows  how  much  is  being 
spent  per  month  in  a  given  department,  how  much  product 
is  being  turned  out  in  that  department,  whether  the  de- 
partment is  doing  its  work  within  the  limit  of  unit  cost 
set  by  the  known  general  trade  averages,  etc.  It  makes 
it  possible,  to  a  certain  extent,  to  apportion  the  expenses 
and  profits  of  doing  business  and  avoids  the  confusion 
which  would  result  if,  for  instance,  a  general  fuel  account 
were  kept  for  the  fuel  outlays  of  Departments  A,  B  and 
C,  notwithstanding  that  the  fuel  outlay  of  A  was  for  run- 
ning machinery,  while  that  of  B  and  C  was  probably  merely 
for  the  sake  of  warmth.  It  has  the  advantage  of  group- 
ing expenses  of  like  kinds  or  those  incurred  for  like  pur- 
poses and  dissociating  those  incurred  for  unlike  purposes. 

Aids  to  the  Accounting. 

We  have  spoken  thus  far  as  if  it  were  comparatively 
simple  and  easy  to  keep  track  of  the  outlays  and.  as  if  they 
could  be  directly  recorded  item  by  item  in  the  appropriate 
accounts  in  each  department — A,  B  and  C.  Such  is  not 
the  case.  It  is  probable  that  the  outlays  will  be  more 
or  less  complex  and  it  is  entirely  possible  that  they  may 
be  made  from  time  to  time  in  comparatively  small  sums. 
This  may  be  particularly  true  of  wages.  Subordinate 
books  therefore  must  be  installed  in  each  department. 
What  will  these  be?  Theoretically,  we  might  employ  a 
day  book  and  journal  just  as  in  the  case  of  the  general 
accounting  system  but  practically  this  will  be  undesirable. 
In  the  case  of  Department  A,  for  example,  it  will  be  un- 
desirable for  the  reason  that  Department  A  does  not  make 
any  sales  but  simply  transfers  its  product  at  a  nominal 
value  to  Department  B.    Its  operations  are  not  fiscal  but 


Analysis  of  Purchases  Boor 


= 

Name 

Fo. 

Spinning  Department 

Weaving  XJepartment 

Mill  General  Expenses                            1 

„,. 

Amount 

of 
Invoice 

Wool 

Tops 

Bands.      f°»n. 
etc          0;1»; 

Sun- 
dries 

Dubbins 
Skips 

Card- 
ciotlis 

Cal-- 
viagee 

Warps 

Wefts 

Dye 
Stuffs 

.Sun- 
dry 

Mater- 
ials 

ShuUles, 

Pickers, 

etc. 

Other 
Pur- 
chases 

Car- 

Motive 
Power 

racl<- 
lUb' 

«'a,er        ^l'» 

un<\            SunJty 

Stores 

«;c 

Other 
Pur- 
chases 

- 

- 

- 

- 

- 

- 

— 

- 

- 

- 

- 

— 

- 

— 

- 

- 

— 

- 

- 

- 

- 

— 

- 

- 

- 

- 

- 



-- 

- 

-- 

- 

-- 

- 

- 

— 

- 

- 

- 

- 

Totals  (or  veai     ... 
Less  (Vedits 

- 

— 

CB 

eadi 

under   respe 

live 

-The  tolalB  for  the  year  are  shown  abo^e,  the  Journal  m  actual  piaclicc  is  totalled  nionthly,  when  the  Accounts  named  at  the  top  of  the  columns  are  debited  vith  their  reapectn 
A  sopaiatu  Book  (or  n  poKiun  of  6«me  Fnok)  is  ruled  eimiliuly  for  Allowances  anu  Keturns. 


THE  PRINCIPLES  OF  ACCOUNTING         119 

are  analytical.  It  is  probable  that  in  most  cases  the  de- 
sirable f  orm^  of  subsidiary  bookkeeping  will  be  a  kind  of 
combination  of  day  book  and  journal.  As  this  will  have 
to  do  with  outlay  or  purchases  chiefly,  it  is  called  by  some 
the  "Purchases  Analysis  Book."*  This  is  a  book  ruled 
for  the  purpose  of  recording  on  successive  days  in  tabular 
form  the  date  of  an  outlay,  the  name  of  the  person  to 
whom  the  sum  was  paid,  the  department  or  branch  of  a 
department  in  the  interest  of  which  it  was  incurred,  and 
the  nature  of  the  goods  received  in  return,  etc.  This  is 
possible  because  the  outlays  are  all  to  be  of  certain  speci- 
fied kinds  and  have  been  analyzed  in  a  preliminary  way 
under  those  groupings.  The  purchases  analysis  book 
simply  records  the  outlays  made  for  goods  as  they  are 
made.  Then,  by  taking  the  different  columns  in  which 
the  amounts  have  been  written  down,  it  is  seen  what  en- 
tries must  be  made  either  individually  or  as  totals  for  the 
day,  week  or  month  in  the  proper  account.  With  refer- 
ence to  wages  it  would  be  possible  to  keep  track  of  the 
wage  payments  by  merely  adding  a  column  in  the  pur- 
chases analysis  book.  Inasmuch,  however,  as  it  is  desired 
to  keep  track  in  such  cases  of  a  great  number  of  individual 
names,  it  is  probable  that  pay-rolls  will  be  employed  by 
most  concerns  unless  the  number  of  employes  is  very  small. 
Such  pay-rolls  will  be  merely  long  sheets  properly  ruled 
and  written  up  each  week  with  the  name  of  the  individual 
to  be  paid  and  the  amount  of  the  payment.  On  receiving 
his  pay  the  individual  may  sign  the  pay-roll  or  otherwise 
vouch  for  the  receipt  of  his  cash.  The  totals  of  the  pay- 
rolls may  then  be  carried  direct  to  the  debit  of  wages  ac- 
count. In  the  purchase  of  raw  materials  or  supplies  it 
may  be  expedient  to  carry  a  special  purchases  analysis 
book  if  the  supplies  are  of  very  detailed  character.    In 

*  A  sample  page  of  such  a  book  with  purchases  classified  for  a  woollen 
factory  is  presented  herewith.  This  example  follows  the  grouping  made  by 
Grierson.  Advanced  Bookkeeping,  p.  108,  from  which  the  illustration  is  taken. 


THE  PRINCIPLES  OF  ACCOUNTINa         119 

are  analytical.  It  is  probable  that  in  most  cases  the  de- 
sirable form  of  subsidiary  bookkeeping  will  be  a  kind  of 
combination  of  day  book  and  journal.  As  this  will  have 
to  do  with  outlay  or  purchases  chiefly,  it  is  called  by  some 
the  ''Purchases  Analysis  Book."*  This  is  a  book  ruled 
for  the  purpose  of  recording  on  successive  days  in  tabular 
form  the  date  of  an  outlay,  the  name  of  the  person  to 
whom  the  sum  was  paid,  the  department  or  branch  of  a 
department  in  the  interest  of  which  it  was  incurred,  and 
the  nature  of  the  goods  received  in  return,  etc.  This  is 
possible  because  the  outlays  are  all  to  be  of  certain  speci- 
fied kinds  and  have  been  analyzed  in  a  preliminary  way 
under  those  groupings.  The  purchases  analysis  book 
simply  records  the  outlays  made  for  goods  as  they  are 
made.  Then,  by  taking  the  different  columns  in  which 
the  amounts  have  been  written  down,  it  is  seen  what  en- 
tries must  be  made  either  individually  or  as  totals  for  the 
day,  week  or  month  in  the  proper  account.  With  refer- 
ence to  wages  it  would  be  possible  to  keep  track  of  the 
wage  payments  by  merely  adding  a  column  in  the  pur- 
chases analysis  book.  Inasmuch,  however,  as  it  is  desired 
to  keep  track  in  such  cases  of  a  great  number  of  individual 
names,  it  is  probable  that  pay-rolls  will  be  employed  by 
most  concerns  unless  the  number  of  employes  is  very  small. 
Such  pay-rolls  will  be  merely  long  sheets  properly  ruled 
and  written  up  each  week  with  the  name  of  the  individual 
to  be  paid  and  the  amount  of  the  payment.  On  receiving 
his  pay  the  individual  may  sign  the  pay-roll  or  otherwise 
vouch  for  the  receipt  of  his  cash.  The  totals  of  the  pay- 
rolls may  then  be  carried  direct  to  the  debit  of  wages  ac- 
count. In  the  purchase  of  raw  materials  or  supplies  it 
may  be  expedient  to  carry  a  special  purchases  analysis 
book  if  the  supplies  are  of  very  detailed  character.     In 


*  A  sample  page  of  such  a  book  with  purchases  classified  for  a  woollen 
factory  is  presented  herewith.  This  example  follows  the  grouping  made  by 
Grierson.  Advanced  Bookkeeping,  p.  108.  from  which  the  illustretion  is  taken. 


120  HENRY  PARKER  WILLIS 

that  case  such  a  book  is  merely  a  section  of  the  general 
purchases  analysis  book.  In  our  foregoing  discussion,  we 
saw  that  the  credit  entries  in  stores  account  as  well  as  in 
all  accounts  involving  materials  will  be  entries  showing 
the  amount  of  materials  issued  from  the  stock  on  hand 
for  the  purpose  of  performing  the  productive  process.  In 
order  to  keep  track  of  these  exactly,  some  system  of  vouch- 
ers and  orders  will  have  to  be  devised  (see  pp.  127,  ff.),  and 
when  th^se  vouchers  or  orders  are  honored,  it  will  be  de- 
sirable to  make  a  preliminary  record  of  them  somewhere 
in  order  to  provide  exact  data  for  writing  up  the  credit 
side  of  the  raw  material,  or  stores  issued,  account  in  the 
ledger.  This  may  be  done  by  providing  a  ''stores  issued" 
book  properly  ruled  with  columns  for  the  date,  name  and 
kind  of  stores  issued.  This  involves  a  ruling  which  will 
provide  a  separate  column  for  each  of  the  principal  kinds 
of  stores  or  materials  and  usually  a  miscellaneous  column 
for  any  additional  unenumerated  material.  It  is  then  pos- 
sible to  have  as  many  different  material  accounts  in  the 
ledger  as  are  desired  or  to  enter  the  amounts  simply  as 
a  total  from  time  to  time  at  their  cost  value. 

Analysis  of  Business. 

In  what  has  been  said  up  to  this  point  reference  has 
been  made  from  time  to  time  to  various  hypothetical  ac- 
counts that  are  supposed  to  be  used  by  a  manufacturing 
department.  The  effort  in  the  foregoing  discussion  has 
been  to  keep  the  analysis  as  simple  as  possible  in  order 
not  to  confuse  the  mind  of  the  reader  with  references  to 
a  great  number  of  different  accounts  the  reason  for  whose 
creation  might  not  be  fully  understood.  It  is  now  neces- 
sary, however,  to  speak  in  a  general  way  of  the  actual 
process  of  analysis  by  which  these  accounts  are  determined. 
We  have  already  said  that  it  is  extremely  desirable  to 
have  each  manufacturing  department  treated  as  if  it  were 
a  separate  business.    This  is  true  because  of  the  desira- 


THE  PRINCIPLES  OP  ACCOUNTING         121 

bility  of  knowing  the  status  of  that  branch  of  the  business 
from  time  to  time  and  thereby  of  comparing  it  with  other 
branches  or  with  the  status  which  experience  in  other 
businesses  had  shown  to  be  desirable.  But  no  such  analysis 
can  be  had  in  a  satisfactory  way,  nor  can  the  accounting 
of  the  manufacturing  department  be  successfully  carried 
out  unless  in  the  first  place  the  business  has  been  care- 
fully organized  with  a  view  to  such  a  conduct  of  the  con- 
cern as  will  permit  of  economical  and  effective  operation. 
One  phase  of  such  economical  and  effective  operation  is 
seen  in  the  economical  and  effective  conduct  of  the  ac- 
counting system.  Such  organization  must  be  of  a  kind 
to  make  careful  separation  (a)  of  the  different  classes  or 
kinds  of  expense  involved  in  the  various  processes;  (b)  of 
the  different  classes  or  kinds  of  material  that  are  pur- 
chased; (c)  of  the  different  classes  and  kinds  of  labor  out- 
lay; (d)  of  the  different  classes  and  kinds  of  product  turned 
out  in  the  department.  The  latter  point  requires  a  word 
of  explanation.  It  has  already  been  said  that  the  business 
should  be  organized  and  the  accounting  carried  on  in  such 
a  way  as  to  keep  the  products  separate  and  permit  no  con- 
fusion to  arise.  A  manufacturing  department  may,  how- 
ever, necessarily  give  rise  to  certain  by-products  whose 
creation  is  inseparable  from  the  manufacture  of  the  prin- 
cipal article  which  is  turned  out.  This  may  necessitate 
a  rather  complex  accounting  problem  because  it  will  be 
difficult  or  impossible  to  apportion  expenses,  stores,  wages, 
etc.,  accurately  between  the  different  kinds  of  product.  It 
should,  however,  be  sought  invariably  to  carry  the  process 
of  apportionment  as  far  as  possible  and  to  avoid  grouping 
together  either  products  or  outlays  any  more  than  is  abso- 
lutely unavoidable.  How  far  the  ianalysis  of  manufactur- 
ing processes  will  go  in  any  particular  instance  depends 
in  part  upon  the  needs  of  the  business,  the  question  of 
its  volume,  the  elaborateness  of  its  transactions  and  other 
factors.    Experience  with  the  given  kind  of  business  indi- 


122  HENRY  PARKER  WILLIS 

cates  the  general  ideas  which  must  govern  in  such  analysis. 
Thus  in  textile  industries  certain  general  lines  that  are 
to  be  follo^Yed,  certain  general  processes  that  are  to  be  dis- 
tinguished from  one  another,  certain  general  results  that 
must  be  kept  in  mind,  are  indicated.  The  same  is  true 
in  the  iron  manufacture  and  in  various  other  general  and 
broad  branches  of  production.  But  it  remains  true  that, 
in  every  business  where  manufacturing  is  carried  on,  the 
general  outline  of  the  accounting  will  have  to  be  deter- 
mined by  means  of  a  study  of  the  business  processes  and 
conditions  which  obtain  in  that  particular  plant.  The  ac- 
counting will  have  to  be  modified  from  time  to  time  be- 
cause of  the  general  changes  in  the  volume  or  complexity 
of  the  business  or  because  of  changes  in  its  administrative 
organization.  For  this  reason  it  is  not  possible  to  lay  down 
in  regard  to  manufacturing  accounting  definite  or  posi- 
tive rules  of  the  kind  that  can  be  laid  down  with  a  greater 
degree  of  assurance  in  the  case  of  the  ordinary  retail  or 
trading  business.  In  the  latter,  the  practice  of  account- 
ing is  much  simpler  and  may  remain  very  much  the  same 
no  matter  what  the  magnitude  of  the  operations  of  the 
business  may  be  and  independent  of  the  number  of  branch- 
es of  trade  that  it  takes  up.  This  is  not  true  of  the  busi- 
ness which  takes  up  another  distinct  branch  of  commercial 
operation  as  where  a  selling  concern  goes  into  manufac- 
turing or  vice  versa.  Still  less  is  it  true  when  the  manu- 
facturing passes  beyond  a  comparatively  elementary  stage. 

IX.    COST  ACCOUNTING. 

Reason  for  Cost  Accounting. 

"We  have  seen  that  in  businesses  which  deal  with  more 
than  one  kind  of  transaction  it  is  desirable  to  separate  the 
operations  so  far  as  possible,  and  if  practicable  to  have  the 
accounting  of  each  department  of  the  business  conducted 
on  as  nearly  independent  a  basis  as  is  feasible.    This  we 


THE  PRINCIPLES  OF  ACCOUNTINa         123 

found  was  desirable  in  the  case  of  the  trading  concern  be- 
cause of  the  desirability  of  keeping  accounts  for  the  dif- 
ferent operations  or  classes  of  goods  separate  from  one 
another.  In  cases  where  the  business  sold  goods  and  also 
manufactured  them,  it  was  necessary  to  keep  track  of  the 
manufacturing,  distinct  from  the  selling,  end  of  the  busi- 
ness, because  of  the  fact  that  one  or  the  other  might  not 
be  economically  handled  and  might  incur  loss  while  the 
other  was  making  a  profit,  as  well  as  for  other  reasons. 
The  idea  of  apportioning  expenses  to  income  or  of  keep- 
ing track  of  each  operation  upon  a  tolerably  independent 
basis  may  be  carried  even  further  than  has  already  been 
indicated.  Such  a  further  working  out  of  the  idea  of  ap- 
portionment of  expenses  to  incomes  relating  to  given  busi- 
ness operations  is  seen  in  what  is  called  ' '  Cost  Accounting. ' ' 
Cost  accounting,  as  the  name  denotes,  is  a  system  of  ac- 
counting which  is  intended  to  give  a  more  distinct  idea  of 
the  actual  cost  of  performing  certain  operations  than  could 
be  obtained  from  the  general  books  of  a  concern  no  mat- 
ter how  carefully  the  latter  might  be  kept.  We  have  seen 
that  a  business  may  be  highly  organized  and  may  be  di- 
vided into  a  number  of  departments  each  of  whose  oper- 
ations is  practically  controlled  on  a  separate  basis  which 
shows  just  what  is  going  on  in  that  department.  We  noted, 
however,  that  even  where  there  is  this  distinct  and  clear- 
cut  separation  there  is  still  no  means  of  knowing  the  exact 
cost  of  units  of  goods.  This  is  lacking  because  (1)  manu- 
facturing is  often  a  more  or  less  continuous  ojDeration  which 
results  in  turning  out  uniform  lots  of  goods  whose  cost, 
however,  varies  according  to  the  cost  of  the  materials  and 
labor  that  go  into  them,  while  (2)  machinery  and  fixed 
capital  is  not  used  up  in  a  single  operation  or  set  of  opera- 
tions but  goes  on  being  used  for  a  longer  or  shorter  period 
according  to  the  life  of  the  various  forms  of  fixed  capital. 
It  is  further  true  that  a  great  many  manufacturing  con- 
cerns are  turning  out  many  di:fferent  kinds  of  products 


124  HENRY  PARKER  WILLIS 

or  are  producing  groups  of  products  on  contracts.  We 
saw  in  our  former  discussion  (see  p.  109)  that  these  fac- 
tors complicate  the  situation  to  such  an  extent  that  it 
may  be  considered  practically  impossible  to  hit  upon  an 
exact  cost  value  representing  the  items  of  labor  and  ma- 
terial entering  into  a  product  and  thus  affording  a  means 
of  balancing  the  books  exactly.  In  order  to  supply  this 
need  we  saw  that  the  ordinary  concern  often  resorts  to  the 
use  of  an  arbitrary  figure  called  a  trc.de  value  which  may 
represent  the  cost  at  which  similar  items  of  product  could 
be  obtained  on  the  market  from  other  concerns  or  which 
may  be  said  to  represent  the  estimated  average  cost  or 
value  which  the  concern  has  found  by  its  own  experience 
to  be  representative  of  the  particular  items  turned  out. 
It  is  clear,  however,  that  this  trade  value  must  be  deter- 
mined somewhere,  either  in  the  other  plants  spoken  of 
or  else  in  the  particular  plant  itself  which  is  being  studied. 
It  is  the  object  of  cost  accounting  to  supply  the  process 
or  mechanism  by  which  this  trade  value  is  ascertained  and 
by  which  the  concern  or  concerns  engaged  in  a  given  line 
of  business  are  enabled  to  judge  whether  their  work  is 
being  done  as  cheaply  as  the  average  in  that  particular 
industry  or  not. 

Object  of  Cost  Accounting. 

The  object  of  cost  accounting  can  now  be  stated  in 
more  technical  form.  It  is  statistical  as  opposed  to  the 
object  of  general  accounting  which  is  fiscal.  This  means 
that  whereas  the  general  accounting  system  of  a  concern 
undertakes  to  show  outlays,  incomes,  profits  and  losses, 
cost  accounting  undertakes  simply  to  show  the  apportion- 
ment of  expenses  and  preferably  the  apportionment  of 
such  expenses  per  unit  of  product  turned  out.  Cost  ac- 
counting is  not  concerned  with  the  question  whether  the 
firm  can  or  does  make  sales  at  a  money  price  which  will 
equal  or  exceed  the  outlays  necessitated  for  the  produc- 


Form 


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THE  PRINCIPLES  OF  ACCOUNTING         125 

tion  of  a  given  class  of  products  or  unit  of  products.  It 
leaves  that  entirely  to  the  managers  of  the  concern  as- 
sisted by  the  general  accounting  system.  It  does  seek  to 
show  what  items  of  expense  have  been  incurred^  for  what 
objects,  and  in  what  proportion.  Experience  shows  wheth- 
er it  was  wise  to  incur  such  expenses  or  to  divide  them 
in  the  way  that  was  actually  followed.  From  the  cost- 
accounting  system  then  it  is  possible  to  infer  or  determine 
what  changes  must  be  made  in  methods. 

Simple  Cost  Accounting. 

A  very  simple  type  of  cost  accounting  would  be  sup- 
plied if  a  concern  were  at  the  end  of  a  fiscal  period  simply 
to  make  out  a  "cost  sheet."  Such  a  cost  sheet  would  be 
nothing  more  than  a  ruled  sheet  with  headings  for  the 
various  items  of  expense.  It  would  be  possible  then  by 
representing  horizontally  the  outlays  on  a  given  under- 
taking or  piece  of  work  and  totaling  them  at  the  end  of 
the  line  to  see  how  much  had  been  spent  on  that  piece 
of  work,  while  by  footing  up  the  different  columns  it  could 
be  ascertained  how  much  had  been  spent  in  each  partic- 
ular class  of  outlay  upon  all  pieces  of  work.  A  sample 
cost  sheet  of  this  kind  is  shown  herewith.  The  theory 
of  the  sheet  is  now  plain  enough.  Suppose  for  the 
sake  of  simple  illustration  that  the  work  is  that  of  a  tailor 
who  is  ordered  to  make  a  suit  of  clothes  for  each  of  ten 
different  persons — A,  B,  C,  D,  etc.  We  may  suppose  that 
the  tailor's  outlays  are  cloth,  wages,  linings  and  sundries, 
and  miscellaneous.  Under  the  latter  head  we  may  class, 
for  the  sake  of  simplicity,  such  items  as  rent,  light,  etc., 
which  are  general  in  character  and  which  we  will  assume 
are  equally  apportioned  by  the  tailor  among  the  ten  suits 
of  clothes — that  is,  if  the  ten  suits  are  each  worth  the 
same  amount — and  if  his  rent  and  light  bill  for  the  week 
is,  say,  $10,  this  may  be  taken  as  roughly  $1  per  suit.  The 
tailor,  wishing  to  see  where  he  stands  at  the  end  of  the 


126  HENRY  PARKER  WILLIS 

week,  enters  A's  suit  as  '' Contract  No.  1"  on  the  first  line, 
then  enters  under  the  head  of  cloth  the  value  of  the  goods 
put  into  the  suit;  under  the  head  of  wages  the  amount 
paid  for  journeymen's  work,  and  under  the  head  of  lin- 
ings and  sundries  the  cost  incurred  on  that  score.    Under 
the  head  of  miscellaneous  he  writes  down  the  estimated 
share  of  general  expenses  borne  by  that  particular  suit. 
He  does  the  same  for  each  of  the  other  nine  contracts  or 
suits  of  clothing.    If  the  cost  sheet  is  inclusive  and  takes 
in  all  contracts  or  business  done  by  the  individual  dur- 
ing the  week  and  all  classes  of  outlay,  it  is  evident  that 
the  cost  sheet  ought  to  harmonize  with  his  general  ledger. 
For  example,  the  total  entries  under  the  wages  column 
ought  to  be  the  same  as  the  outlays  exhibited  in  labor 
or  wages  account  in  the  ledger.     The  total  outlays  for 
miscellaneous  (rent,  light,  etc.)  ought  to  be  the  same  as 
the  sum  of  the  entries  in  the  ledger  accounts  relating  to 
the  items  grouped  under  that  head.    The  same  is  true  of 
other  outlay  accounts.    Of  course  the  tailor  will  carry  in 
his  general  ledger  personal  accounts  with  the  different  in- 
dividuals, A,  B,  C,  etc.,  who  have  ordered  the  suits,  but 
presumably  the  debit  entry  in  each  of  these  accounts  will 
be  for  a  suit  at  the  agreed-upon  selling  value  mentioned 
to  the  customer  at  the  time  he  made  the  purchase,  while 
he  will  be  credited  with  a  check  or  cash  for  the  amount 
when  he  pays.    If,  however,  the  tailor  desired,  he  might 
debit  the  customer  with  the  actual  cost  value  of  the  suit 
as  worked  out  on  the  cost  sheet  and  then  add  another 
debit  item  showing  the  profit  on  that  particular  suit  which 
of  course  will  be  equal  to  the  difference  between  the  agreed- 
upon  supply  price  to  the  customer  and  the  cost  as  ascer- 
tained from  the  cost  sheet.    In  this  case  the  cost  sheet 
would  have  only  an  auxiliary  relation  to  the  general  books. 
It  would  be  merely  a  statistical  memorandum  worked  out 
by  the  proprietor  from  the  general  books  for  his  own  in- 
formation.   It  might  turn  out  upon  such  an  examination. 


THE  PRINCIPLES  OP  ACCOUNTINa         127 

that  the  cost  of  some  of  the  suits  of  clothing  furnished 
was  greater  than  the  actual  selling  price  but  the  general 
books  would  not  indicate  on  their  face  whether  this  was 
true  or  not.  The  utihty  of  such  a  cost  sheet  is  there- 
fore obvious  and  it  will  be  understood  that  the  reason 
for  making  it  out  and  carefully  comparing  it  with  the  re- 
turns shown  by  the  general  books  becomes  more  and  more 
pressing,  the  more  complex  are  the  kinds  of  work  engaged 
in. 

Individual  Cost  Sheets. 

Suppose  the  tailor  or  any  other  producer  on  thinking 
the  matter  over  does  not  like  the  idea  of  waiting  until 
the  end  of  the  week  or  month  and  then  computing  a  cost 
sheet  to  show  the  results  of  the  several  transactions  re- 
lating to  a  given  contract  or  piece  of  work.  He  may  men- 
tally recognize  the  advisability  of  keeping  this  informa- 
tion up  to  date  as  he  goes  along.  Suppose  then  that  he 
provides  himself  with  a  set  of  blanks  or  blank  forms  in- 
tended to  go  with  each  contract  that  is  accepted.  If  A 
enters  the  shop  and  orders  a  suit  of  clothes  one  of  these 
forms  may  be  filled  in  at  the  top  with  the  name  *'A"  in 
a  space  provided  for  that  purpose.  (For  sample  see  p.  12'5.) 
Then  as  the  suit  passes  on  from  worker  to  worker  it  is 
accompanied  by  this  blank,  which  is  gradually  filled  in 
with  labor  charges,  goods  used,  sundries  put  into  the  suit, 
etc.,  etc.  After  the  suit  has  been  completely  manufac- 
tured the  proprietor  may,  if  he  chooses,  add  an  entry  rep- 
resenting the  assignment  of  general  expenses  which  he 
thinks  ought  to  belong  to  every  suit  of  clothes  turned  out. 
He  will  then  have  on  this  tag,  or  voucher,  or  slip,  a  com- 
plete statement  of  the  history  of  the  piece  of  work.  Sup- 
pose at  the  end  of  the  week  he  has  fifty  such  vouchers 
or  slips.  It  is  merely  a  routine  matter  to  tabulate  these 
returns  on  a  general  cost  sheet  of  the  kind  already  indi- 
cated.   Meanwhile,  presumably,  the  tailor  has  kept  up  his 


128  HENRY  PARKER  WILLIS 

general  books.  Under  wages  he  has  recorded  all  payments 
for  wages;  under  material  he  has  debited  all  material  paid 
for,  and  credited  all  material  issued,  etc.  On  the  slips  or 
blanks  it  is  probable  that  his  labor  charges  will  have  been 
entered  as  number  of  hours  of  labor  of  a  given  kind  spent 
on  each  suit  of  clothes  but  by  making  a  careful  estimate 
of  the  actual  cost  of  labor  per  hour  it  is  an  easy  matter 
to  harmonize  the  cost  sheet  with  the  showing  made  in  the 
general  ledger  account.  If  the  slips  are  carefully  made  out 
and  if  the  assignment  of  general  expenses  is  correctly 
made,  the  tailor  will  have  a  fairly  good  idea  of  the  ques- 
tion whether  or  not  he  is  making  a  profit  on  a  given  class 
of  work.  He  will  be  able  to  estimate  whether  he  makes 
a  larger  profit  on  his  higher  cost  suits  or  whether  his  profit 
is  larger  on  the  cheaper  suits.  He  will  thus  be  able  to 
form  an  opinion  whether  to  put  the  stress  on  the  one  or 
the  other  branch  of  his  business.  For  his  purposes  this 
may  be  a  sufficiently  satisfactory  system  of  cost  account- 
ing although  the  cost  records  will  not  have  entered  in  any 
way  into  the  general  books  unless  the  tailor  has  chosen 
to  record  the  actual  cost  of  each  suit  as  shown  by  its  indi- 
vidual cost  sheet  or  slip  on  the  debit  side  of  the  customer's 
account,  the  difference  between  that  and  the  credit  side 
(the  amount  ultimately  paid  in  in  cash)  being  the  profit 
(or  loss). 

Cost  Accounts  in  the  General  Books. 

Could  not  the  tailor  or  other  contractor  have  his  cost 
accounting  a  part  of  his  general  accounting  system"? 
From  what  has  been  said  it  is  clear  that  there  is  no  ab- 
stract reason  why  he  should  not.  For  instance,  when  he 
makes  an  agreement  with  A  to  supply  A  with  a  suit  of 
clothes,  he  may  open  A's  account  in  his  ledger  and  on  the 
debit  side,  as  outlays  are  made,  he  might  debit  A  with 
the  cost  value  of  the  items  going  into  his  suit  of  clothes. 
When  A  paid  his  indebtedness  at  the  agreed-upon  rate, 


THE  PRINCIPLES  OF  ACCOUNTING         129 

credit  would  be  given  him  and  thus  the  account  would 
show  just  what  had  gone  into  A's  suit  and  what  had  been 
realized  from  it,  the  result  being  a  profit  (or  loss)  and  as 
such  transferred  to  profit  and  loss  account.  Here  the  en- 
tries would  be  carried  as  an  integral  part  of  the  bookkeep- 
ing. For  instance,  if  three  yards  of  cloth  were  used  in 
making  the  suit  of  clothes,  this  might  be  entered  as  a 
credit  in  cloth  or  stock  account  and  then  entered  as  a 
debit  in  A's  account.  When  A  paid  for  his  clothes  he  would 
be  credited  with  the  cash  and  cash  account  would  be  debit- 
ed with  the  amount  he  paid  in.  Here  there  would  be  a 
perfect  double  entry,  and  the  books  of  course  would  bal- 
ance if  every  item  was  thus  accurately  determined  and 
entered.  Eoughly  speaking  the  general  ledger  would  con- 
sist then  of  a  series  of  accounts  showing  general  cash  out- 
lays on  expense  items,  as  wages,  rent,  light,  heat,  ma- 
terials, etc.,  and  a  collection  of  personal  accounts  show- 
ing debit  entries  for  the  apportionment  or  assignment  of 
these  expenses  that  went  to  the  working  out  of  the  dif- 
ferent contracts.  Whenever  money  was  originally  spent 
for,  say,  materials,  it  would  be  a  credit  in  cash  and  a  debit 
in  materials  account.  Whenever  materials  were  dra^vn 
from  the  stock  on  hand  and  worked  up  or  whenever  labor 
was  exerted,  it  would  give  rise  to  a  debit  in  the  account 
relating  to  the  particular  contract  on  which  it  was  expend- 
ed, and  a  corresponding  credit  entry  in  the  account  re- 
lating to  the  kind  of  material  or  labor  which  was  drawn 
upon.  If  50  yards  of  a  certain  kind  of  cloth  were  cut  up 
on  a  certain  day  for  a  number  of  different  suits  of  clothes, 
material  account  would  be  credited  with  50  yards  of  cloth 
at  the  cost  value  thereof,  while  the  various  personal  ac- 
counts would  be  debited  with  the  several  quantities  of 
cloth  that  had  gone  into  the  making  of  the  several  suits 
of  clothing.  The  ^'cost  accounting"  would  be  seen  in  the 
fact  that  there  had  been  a  segregation  and  assignment  of 
cost  elements  to  every  operation  or  transaction  involving 

B— VIII— 9 


130  HENRY  PARKER  WILLIS 

the  use  of  those  elements  for  the  production  of  a  particu- 
lar result.  Here,  it  is  plain,  the  cost-keeping  system  would 
be  a  part  of  the  general  bookkeeping.  This  might  be  man- 
aged by  the  same  general  system  of  tickets  or  slips  ac- 
companying the  work  in  process  that  has  already  been 
described,  the  accounts  in  the  ledger  being  written  up 
from  these  slips  as  original  records,  or  the  slips  might 
be  recorded  in  some  book  of  original  entry  or  filing  system 
prior  to  writing  them  up  in  the  general  ledger.  This  would 
be  a  detail  to  be  arranged  as  the  particular  business  and 
its  needs  might  require.  Would  this  be  a  desirable  way 
of  handling  the  problem?  **The  ideal  cost  account,"  says 
Mr.  Lisle,  "is  one  which  is  kept  as  a  part  of  the  double 
entry  bookkeeping.  Under  such  a  perfect  system  the  man- 
ufacturing or  trading  account  is  done  away  with,  and  its 
place  is  taken  by  as  many  departmental  or  separate  cost 
accounts  as  there  are  departments  or  different  articles 
manufactured."  Mr.  Lisle 's  statement  is  undoubtedly  cor- 
rect notwithstanding  the  fact  that  many  concerns  do  not 
attempt  to  keep  their  cost  accoimts  as  a  part  of  the  gen- 
eral books  for  reasons  which  we  shall  enlarge  on  presently. 
It  does  not  follow,  however,  that  such  an  ideal  cost  ac- 
counting will  thus  be  kept  directly  in  the  general  books 
even  though  the  cost  accounting  is  carried  on  as  *'a  part 
of"  the  double  entry  system. 

Cost  Books. 

It  is  clear  that  as  soon  as  work  arrives  at  any  great 
degree  of  complexity  the  number  of  entries  requiring  to 
be  made  in  any  given  cost  account  is  far  too  great  to  ad- 
mit of  their  being  kept  in  the  way  just  indicated.  More- 
over as  the  degree  of  complexity  of  the  work  becomes 
greater  and  as  the  elements  of  general  expense  which  must 
be  estimated  and  apportioned  become  more  and  more  diffi- 
cult to  determine  with  accuracy,  it  will  be  proportionately 
harder  to  maintain  a  correct  double  entry  system.    The 


THE  PRINCIPLES  OF  ACCOUNTINa         131 

first  step  away  from  the  system  already  indicated  wiQ 
undoubtedly  be  that  of  transferring  the  accounts  of  the 
several  contracts  or  pieces  of  work  in  progress  into  a  so- 
called  ''contract  ledger."  This  will  be  analogous  to  the 
simple  "sold  ledger"  which  we  spoke  of  at  a  much  earlier 
point  in  our  discussion  (see  p.  31).  The  transfer  is 
here  merely  a  matter  of  convenience,  the  personal  accounts 
being  perhaps  retained  in  the  general  ledger  in  a  simple 
form,  the  debit  entry  for  A,  for  example,  being  *'To  1  suit 

of  clothes $40,"  and  the  credit  entry  ''By  cash 

$40,"  while  the  real  details  of  what  has  gone  into  A's  suit 
are  kept  in  a  contract  ledger,  a  "contract  ledger  account" 
being  ultimately  established  in  the  general  ledger  for  the 
purpose  of  showing  actual  profits  or  losses  realized.  Or 
the  contract  ledger  may  be  treated  simply  as  a  convenient 
form  of  record,  the  debit  entries  only  being  set  down  in 
the  various  accounts  and  being  then  transferred  to  the 
debit  side  of  the  personal  accounts  in  the  general  ledger. 
In  this  case  the  situation  is  just  the  same  as  it  Avas  when 
all  of  the  accounting  was  recorded  in  the  general  ledger, 
the  only  difference  being  that  the  details  are  for  the  sake 
of  convenience  collected  in  a  separate  book.  This  method 
has  the  advantage  of  rendering  it  possible  to  write  up  the 
subordinate  books  from  period  to  period,  merely  transfer- 
ring the  totals  to  the  general  ledger.  Thus,  for  example,  the 
contract  ledger  could  be  posted  only  from  such  a  set  of 
tickets  or  slips  accompanying  the  different  contracts  as 
has  already  been  described  or  from  these  in  conjunction 
with  a  "stores  issued"  book  in  which  would  be  recorded 
the  amounts  of  goods  drawn  from  the  stock  on  hand  for 
consumption  or  working  up.  So  also  either  the  pay-roll 
or  an  abstract  of  wages  paid  could  be  used  for  the  purpose 
of  posting  wages.  Then,  say  at  the  end  of  each  week,  the 
total  wages  paid  could  be  posted  to  wages  account  in  the 
general  ledger,  total  stores  issued  could  be  posted  to  ma- 
terials account  or  the  various  materials  accounts  in  the 


132  HENRY  PARKER  WILLIS 

general  ledger,  etc.    The  tickets  or  slips  accompanying  each 
order  or  contract  would  furnish  the  data  for  posting  to 
the  debit  side  of  each  contract  in  the  contract  ledger.    It 
is  plain  that  if  a  debit  entry  were  made  in  some  contract 
account  for  every  item  of  goods  or  labor  used  and  if  all 
items  of  goods  or  labor  used  were  credited  to  the  proper 
accounts  in  the  general  ledger  as  totals,  the  gross  debit 
entries  in  the  various  contract  accounts  would  equal  the 
gross  credit  entries  in  the  various  outlay  or  materials  ac- 
counts.   The  general  ledger  would  thus  be  kept  compact 
with  but  few  entries  while  the  details  of  wages  paid  would 
be  obtained  from  the  pay-rolls  or  an  abstract  of  pay-rolls, 
the  details  of  materials  used  would  be  obtained  from  a 
book  kept  for  that  purpose,  etc.    Suppose  that  some  error 
had  been  made  in  assigning  elements  of  cost  to  the  differ- 
ent pieces  of  work — say,  for  instance,  that  the  cloth  for 
A's  suit  of  clothes  is  set  down  as  3  yards  worth  $12  on  his 
voucher  or  slip,  whereas  in  the  record  of  materials  issued 
it  appears  as  $11.    Here  there  is  a  discrepancy  of  $1.    This 
means  that  whereas  a  credit  entry  of  $11  will  be  included 
in  the  general  credit  entry  for  the  week  in  materials  ac- 
count, a  debit  entry  of  $12  is  placed  on  A's  accoimt  or 
Contract  No.  1  or  whatever  it  is  called.    This  will  be  equal- 
ized when  the  books  are  balanced  since  when  A  pays  his 
bill  this  will  give  rise  to  a  credit  entry  of  $40,  the  originally 
fixed  price  of  the  clothes,  in  his  account,  and  a  debit  entry 
of  $40  in  the  cash  account.  A's  account  will  be  balanced  by 
transferring  the  profit  on  his  contract,  say  $5,  to  profit  and 
loss.  In  balancing  material  account  it  will  be  necessary  to 
ascertain  the  value  of  the  goods  remaining  on  hand  by  an  in- 
ventory process,  the  balance,  of  course,  being  transferred 
to  profit  and  loss.    The  same  thing  will  be  true  at  other 
points  at  which  the  estimate  of  cost  on  the  several  con- 
tracts  has   not   been   strictly   accurate.     The   variation, 
whether  in  favor  of  or  against  the  concern,  will  be  trans- 
ferred to  profit  and  loss  and  will  there  simply  make  profit 


THE  PRINCIPLES  OP  ACCOUNTINa         133 

greater  or  less,  or  less  or  more  than  it  would  otherwise 
have  appeared.  An  approximation  to  accuracy  will,  how-^ 
ever,  have  been  attained,  the  cost  system  continuing  as 
a  part  of  the  general  books.  Somewhat  the  same  end  could) 
be  attained  by  carrying  what  is  known  as  a  cost  adjust- 
ment account. 

If  the  purchasing  system  of  the  concern  is  elaborate, 
a  bought  ledger  precisely  similar  to  the  bought  ledger  of 
the  retail  business  (see  p.  31  foregoing)  will  also  be  needed 
and  will  be  carried  on  parallel  with  the  contract  ledger,  of 
which  it  will  be  the  obverse.  This  bought  ledger  will  re- 
lieve the  general  ledger  of  the  accounts  which  are  entered 
in  it.  Both  for  it  and  for  the  contract  ledger  a  system  of 
subordinate  books  will  be  needed.  Thus  subsidiary  to  the 
bought  ledger  will  be  the  bought  ledger  cash  book,  bills 
payable  book,  etc.;  and  subsidiary  to  the  contract  ledger 
will  be  the  contract  cash  book  and  bills  receivable  book,  as 
well  as  others  intended  merely  to  classify  transactions  and 
render  the  posting  easier.* 

Cost  Ledger. 

Another  step  toward  putting  the  system  of  cost  keep- 
ing into  a  more  perfect  form  may  be  taken  by  the  es- 
tablishment of  what  is  called  a  "Cost  Ledger."  Such  a 
cost  ledger  for  contracts  of  the  kind  that  we  have  been 
speaking  of  is  illustrated  on  page  137.  A  cost  ledger 
is  simply  a  continuous  summary  of  outlays  on  the  same 
general  principle  as  that  which  was  adopted  for  the  cost 
sheet.  Where  the  contract  is  elaborate  and  the  number 
of  contracts  is  great  it  may  be  deemed  best  to  set  aside  a 
given  page  or  pages  for  each  contract.  The  ledger  will 
then  be  ruled  so  as  to  provide  a  number  of  columns  on  the 
debit  side  for  the  purpose  of  recording  the  different  ele- 
ments of  cost  or  outlay.  Thus  there  may  be  columns  show- 
ing the  number  of  days  or  hours  of  work  spent  on  the  con- 
tract on  a  particular  day,  the  wages  paid  therefor,  the 

♦  Cf.  D-icksee's  Bookkeeping  for  Accountant  Students,  pp.  229  ff. 


134  HENRY  PARKER  WILLIS 

materials  used,  plant  destroyed,  the  assignment  of  gen- 
eral expenses  and  any  other  items  that  may  be  desired. 
It  is  customary  to  put  on  the  credit  side  of  the  cost  ledger 
not  only  the  stated  contract  price  but  also  in  a  separately 
ruled  column  such  items  of  materials  as  are  returned  un- 
used, items  of  tools  or  plant  that  are  returned  in  an  un- 
used or  partly  unused  condition,  and  so  on.    The  sum  total 
of  debit  entries  for  wages,  materials,  plant,  etc.,  can  then 
be  footed  up  when  the  contract  is  completed  and  accepted, 
the  total  of  credit  entries  can  be  similarly  entered  and 
the  difference  will  represent  the  profit  on  that  particular 
contract.    Here  we  have  exactly  the  same  principle  that 
was  employed  in  our  last  hypothetical  illustration — that  of 
the  contract  ledger,  the  difference  being  that  in  this  case 
provision  is  made  for  analytical  treatment  of  the  different 
elements  of  cost.    If  there  are  100  contracts  in  the  cost 
ledger,  the  total  outlay  for  wages,  materials,  etc.,  on  all 
contracts,  should  equal  the  total  amounts  of  expenditure 
indicated  on  the  corresponding  outlay  accounts  in  the  gen- 
eral ledger.    Before  closing  the  cost  ledger  there  will  be 
drawn  off  or  written  up  a  summary  of  the  cost  ledger  in 
which  will  be  exhibited  the  summarized  results  of  the  out- 
lays on  each  contract  as  well  as  the  summarized  results 
of  all  credit  entries  (contract  price,  materials  returned, 
etc.),  while  there  will  be  inserted  columns  showing  profit 
and  loss  on  the  various  contracts  which,  when  summarized 
and  offset  against  one  another,  will  show  net  profit  or  net 
loss  for  the  period  under  consideration.    The  double  entry 
system  of  the  cost  ledger  would  not  be  complete  by  itself 
if  it  included  only  what  has  been  set  down.    By  opening 
a  contracts  account  and  posting  totals  to  it  a  check  is  ob- 
tained which  may  be  availed  of  for  the  purpose  of  locat- 
ing any  error.    The  cost  ledger  has  been  closed  when  the 
total  footings  of  all  accounts  therein  have  been  made  and 
found  to  agree.    If  the  results  of  each  separate  contract 
as  exhibited  in  the  cost  ledger  are  transferred  to  the  per- 


THE  PRINCIPLES  OF  ACCOUNTING         135 

sonal  account  relating  thereto  in  the  general  ledger,  there 
is  no  need  of  maintaining  a  contract  ledger  although  this 
may  be  done  if  desired.  The  relation  of  the  cost  ledger 
to  the  other  ledgers  or  to  the  general  ledger  is  no  different 
from  that  of  any  ledger,  if  the  accounting  be  carried  on 
as  above  indicated.  The  contract  ledger  (which  is  analo- 
gous to  the  sold  ledger  of  a  trading  concern)  may  carry 
on  the  debit  side  of  each  account  the  contract  price  at 
which  the  work  was  undertaken  and  carried  out,  while 
on  the  credit  side  will  be  recorded  payments  made  from 
time  to  time  until  the  agreed  sum  is  liquidated.  Thus  sup- 
pose an  account  to  be  opened  with  '^  Contract  No.  1 — John 
Smith  &  Co.,"  the  entries  are  as  indicated.  Meanv/hile 
in  the  cost  ledger  a  similar  account  is  opened  where  the 
actual  outlays  on  Contract  No.  1  are  recorded  as  they  are 
made  from  general  cash,  being  debited  there  as  fast  as 
they  are  paid  and  credited  to  cash.  When  the  account 
of  Contract  No.  1  is  closed  in  the  cost  ledger  it  shows 
either  a  profit  or  a  loss.  Transferring  this  to  a  contracts 
account  which  supplies  a  means  for  recording  the  final  data 
obtained  from  the  accounting,  there  will  appear  a  series 
of  debit  items  showing  losses,  if  any,  on  various  contracts 
performed  and  a  series  of  credit  items  showing  profits, 
if  any,  on  the  various  contracts.  This  is  practically  a  trad- 
ing account  which  will  furnish  the  material  for  writing  up 
the  profit  and  loss  account  in  the  general  ledger.  The  ac- 
counting shows  what  has  been  gained  or  lost  on  each  con- 
tract, the  assumption  being  of  course  that  the  cash  can  be 
collected  to  the  full  contract  amount  on  each.  When  a  con- 
tract is  paid  for,  the  general  cash  account,  of  course,  is  deb- 
ited, while  the  account  with  that  particular  contract  or  the 
person  in  whose  behalf  it  has  been  undertaken  is  credited. 
The  cost  ledger  does  not  enter  into  this  transaction  at  all. 
It  has  done  its  work  in  segregating  the  debit  entries  which 
were  necessitated  by  the  payment  of  cash  from  time  to  time 
and  in  comparing  them  with  the  amount  of  cash  which  it  is 


136  HENRY  PARKER  WILLIS 

expected  to  receive.  Of  course  all  the  subsidiary  books 
already  referred  to  will  necessarily  be  carried  on  and  their 
number  will  depend  upon  the  character  of  the  business. 
Such  subsidiary  books  will  include  the  stores  or  material- 
issued  book,  the  stores  or  material-returned  book,  the  plant- 
issued  and  plant-returned  books,  the  stores-purchased 
book,  and  others  as  needed.  Where  the  business  is  simple  it 
is  possible  to  carry  on  the  accounting  for  the  stores  issued, 
purchased  and  returned  in  the  same  book  by  having  ap- 
propriate rulings.  A  sample  sheet  of  the  cost  ledger  is 
shown  on  p.  137.  On  p.  138  is  given  a  sample  sheet  of  a 
material  record. 

Analysis  of  Costs. 

Enough  has  now  been  said  by  way  of  illustration  to 
show  how  the  cost  books  of  a  concern  are  designed  and 
the  purpose  for  which  they  are  carried  on.  It  is  next  nec- 
essary to  inquire  whether  all  cost  analyses  can  be  made 
upon  the  principle  just  indicated  and,  if  not,  what  prin- 
ciples of  analysis  of  cost  must  be  employed  in  order  to 
render  possible  a  cost-keeping  sj^stem  which  will  attain 
substantially  the  same  end.  Just  here  it  is  well  to  note 
that  the  illustration  assumed  for  purposes  of  discussion 
is  the  simplest  that  could  have  been  given.  It  will  be 
noted  that  we  base  our  analysis  on  the  assumption  that 
what  the  manufacturer  or  producer  sought  to  do  was  to 
keep  his  account  of  costs  with  a  series  of  individual  con- 
tracts each  of  which  was  supposed  to  be  separately  ac- 
complished, and  to  give  rise  to  a  series  of  items  that  are 
immediately  turned  over  to  a  purchaser  who  has  contract- 
ed for  them  at  a  definite  price.  This  is  truly  enough  rep- 
resentative of  certain  classes  of  business  such  as  is  seen 
in  the  case  of  engineering  works,  the  construction  of  ma- 
chinery of  various  kinds  on  order,  the  performance  of 
simple  production  (as  in  the  case  of  clothing  manufacture 
in  the  illustrations  already  given)  and  in  many  others. 


THE  PEINCIPLES  OP  ACCOUNTINa 


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138 


HENRY  PARKER  WILLIS 


MATERIAL  ISSUED. 

June,  1910. 


Contract 
No.   1. 
No. 


Contract 
No.   2. 


Contract 
No.   3. 


Contract 
No.  4. 


No.    t 


Contract 
No.  6. 


No.    t 


Contract 
No.  6. 


No.    t 


Contract       Contract 

No.   7.  No.  8; 

No.    t  No.    4 


Note. — In  the  columns  headed  "No."  will  be  recorded  the  number  of  the 
requisition  for  supplies  or  material,  such  requisitions  being  filed  separately 
and  constituting  a  record  of  all  issues.  In  the  columus  headed  "$"  are  recorded 
the  cost  value  of  the  material  issued.  The  book  might  be  ruled  with  selected 
headings  at  the  top  of  columns  showing  standard  classes  of  supplies  issued,  as 
lumber,  nails,  etc.  The  requisitions  could  be  made  to  show  the  contracts  for 
which  the  issue  took  place. 

It  is  not  the  case,  however,  with  those  businesses  where 
the  processes  are  continuous  and  where  the  product  is 
turned  out  not  on  the  basis  of  an  established  contract 
price,  but  upon  that  of  future  sale  at  such  price  as  the 
market  may  warrant.  For  example,  take  the  case  of  a 
factory  producing  plain  cotton  goods  for  the  purpose  of 
building  up  its  warehouse  stock  in  order  to  meet  orders 
which  it  knows  will  be  received  during  the  coming  season, 
or  the  case  of  a  shoe  factory  which  devotes  itself  to  pro- 
ducing a  full  line  of  sizes  of  various  grades  of  footwear, 
knowing  that  there  will  be  a  demand  for  footwear  and 
expecting  to  supply  this  demand  by  selling  the  output  in 
its  retail  stores  which  it  may  have  established  here  and 
there.  Such  enterprises  cannot  organize  their  cost  sys- 
tems in  the  way  already  indicated.  They  cannot  do  so 
for  the  reason  that  the  basis  of  accounting  previously 
adopted  is  absent.  Although  it  is  very  desirable  to  estab- 
lish a  unit  cost  for  the  cloth  per  yard,  it  is  not  possible  to 
keep  account  with  every  yard  of  cloth  produced.  The  same 
is  true  of  the  shoes.  It  may  not  even  be  possible,  as  in 
the  cases  already  cited,  to  keep  account  with  every  par- 


THE  PRINCIPLES  OP  ACCOUNTING         139 

ticular  batch  of  output.  Here  the  difficulty  lies  in  the  fact 
that  a  new  basis  for  the  cost  accounting  must  be  sought. 
The  basis  desired  is  that  of  unit  cost  in  the  last  analysis, 
but  this  can  be  secured  only  by  keeping  account  with  pro- 
cesses. Thus  is  presented  perhaps  the  most  difficult  prob- 
lem of  cost  accounting — that  of  accurately  getting  at  the 
costs  involved  in  the  various  processes  through  which 
goods  pass  in  their  progress  toward  completion. 

Bases  of  Cost  Accounting. 

We  have  now  laid  the  foundation  for  an  understand- 
ing of  the  different  bases  upon  which  cost  accounting  may 
be  carried  on.  The  first  was  that  of  individual  contracts 
or  pieces  of  work,  the  second  that  of  processes.  The  lat- 
ter, however,  may  be  still  further  subdivided.  In  a  ma- 
chine type  of  industry  it  may  be  resolved  to  keep  track 
of  the  cost  by  machines  or  it  may  be  determined  that  the 
best  system  is  that  which  will  take  account  of  the  whole 
process  in  which  these  machines  are  used.  If,  for  example, 
there  are  three  classes  of  machines  through  which  a  given 
product  has  to  pass  on  its  way  to  completion,  account  may 
be  kept  with  each  of  these  machines.  Thus,  say,  logs  are 
taken  into  a  planing  mill  and  are  run  through  saws  which 
convert  them  into  boards.  Then  they  are  run  through 
jolaners  for  the  purpose  of  smoothing,  then  they  may  be 
tongued  and  grooved  in  order  to  provide  means  for  fitting 
them  together  when  they  are  laid.  Supposing  that  in  this 
mill  the  saws,  planers,  and  the  machines  for  tonguing 
and  grooving  are  grouped  together  in  different  parts  of 
the  plant,  it  would  be  possible  to  keep  track  of  the  amount 
of  work  done  by  each  machine — that  is,  the  number  of 
hours  it  was  run,  the  estimated  expense  of  running  it,  the 
estimated  depreciation,  etc.  If  all  the  work  were  done 
by  the  use  of  machines  and  if  every  machine  were  thus 
kept  track  of,  a  basis  for  the  cost  accounting  would  be 
established.    Or,  it  might  be  decided  to  base  the  account- 


140  HENRY  PARKER  WILLIS 

ing  upon  processes.  In  this  case,  every  time  a  piece  of 
material  was  put  through  a  given  process,  opportunity 
would  be  offered  for  entries  in  the  account  relating  to 
that  process.  To  sum  up  what  has  been  said,  we  may 
enumerate  the  different  methods  of  keeping  costs  in  their 
principal  forms  as  follows:*  (1)  The  cost  system  in  which 
the  records  are  kept  according  to  order  number;  (2)  the 
cost  system  in  which  the  records  are  kept  according  to 
departments;  (3)  the  cost  system  in  which  the  records 
are  kept  according  to  the  operations  or  processes;  (4)  the 
cost  system  in  which  the  records  are  kept  according  to 
machines.  The  explanations  already  given  indicate  the 
method  of  the  accounting  according  to  the  basis  which 
may  have  been  adopted.  In  the  case  of  the  order  num- 
ber system  the  cost  sheet  is  prepared  so  as  to  analyze  ex- 
penditures on  the  given  order;  in  the  department  system 
the  cost  sheet  represents  the  results  for  the  department; 
in  the  operation  or  process  system  the  sheet  is  kept  for 
the  operation  or  process  and  the  results  show  expendi- 
tures and  incomes  resulting  from  that  process;  in  the  ma- 
chine system  the  cost  sheet  represents  results  for  given 
machines  or  sets  of  machines.  In  every  case  the  ultimate 
object  is  that  of  ascertaining  cost  per  unit.  The  accounts 
in  the  cost  ledger  follow  these  cost  sheets  and  the  cost  led- 
ger, if  one  is  kept,  is  related  to  the  other  books  in  the  way 
that  has  already  been  described.  Essentially,  then,  the 
problem  in  cost  accounting  as  applied  to  modern  business  is 
twofold:  (1)  That  of  ascertaining  the  best  plan  for  analyz- 
ing costs  in  the  given  business  and  of  organizing  the  busi- 
ness to  correspond;  and  (2)  that  of  assigning  a  given  rate  of 
expense  or  cost  to  various  operations  or  processes  in  those 
cases  where  the  exact  ascertainment  of  the  cost  involved  is 
not  practicable.  It  is  to  be  noted  that  the  accounting  scheme 
is  the  same  in  all  of  these  plans,  the  difference  residing 


*  The  classification  here  given  is  found  in  C.  M.  Day's  Accounting  Prac- 
tice, pp.  91-2, 


THE  PRINCIPLES  OF  ACCOUNTINa         141 

solely  in  a  difference  of  organization.  The  basis  of  the 
accounting  scheme  lies  in  the  fact  that  cash  is  paid  out 
from  cash  account  for  the  various  elements  of  cost  which 
may  be  reckoned  as  raw  material,  labor  and  expense  and 
that  these  different  items  and  the  accounts  correspond- 
ing to  them  are  drawn  upon  for  the  means  of  carrying  on 
the  operation  or  performing  the  unit  of  work  or  contract 
which  has  been  accepted  as  the  basis  of  the  cost  account- 
ing, while  this  operation,  process,  or  other  basis  of  ar- 
rangement is  conceived  as  furnishing  completed  goods 
either  to  some  other  operation,  process  or  the  like  or  to 
the  selling  end  of  the  business,  thus  in  the  last  analysis 
bringing  in  cash  from  the  outside  world  w^hich  goes  to 
cash  account.  From  this  it  is  plain  that  as  cash  is  paid 
out  it  is  credited  to  cash  account,  while  corresponding 
debits  go  to  material,  labor,  and  expense  or  are  subdivided 
among  the  various  accounts  belonging  to  the  groups  thus 
indicated.  In  the  cost  sheets  or  accounts  the  material, 
labor  and  expense  paid  out  are  debited  to  the  various  con- 
tracts, processes,  machines,  or  units  of  product  which  have 
been  accepted  as  the  basis  for  the  accounting.  The  comple- 
tion of  processes,  contracts,  etc.,  results  in  crediting  the  cost 
sheets  or  accounts  with  the  value  of  the  work  turned  out 
w^hich  may  then  be  debited  to  a  production  account,  and 
when  the  goods  are  sold  or  transferred,  production  account 
receives  corresponding  credit,  while  the  amount  of  cash 
realized  is  debited  to  cash  account. 

Selecting  a  Cost  System. 

From  what  has  been  said  it  will  be  appreciated  that 
in  selecting  a  cost  system  the  matter  of  fundamental  im- 
portance is  to  get  a  system  that  is  well  adapted  to  the  busi- 
ness in  question  and  that  permits  of  substantial  accuracy. 
Unless  a  cost  system  is  reasonably  accurate  it  is  not  only 
useless  but  even  may  be  injurious  or  detrimental  to  the 
welfare  of  the  business.    We  have  seen  that  where  actual 


142  HENRY  PARKER  WILLIS 

expenses  can  be  apportioned  there  is  a  very  great  utility 
in  the  adoption  of  some  system  that  will  permit  such  ap- 
portionment.   For  example,  in  the  case  of  given  orders  or 
contracts,  it  is  entirely  possible  to  segregate  the  outlays 
as  indicated.    As  soon  as  percentages  of  general  expense 
and  the  like  must  be  computed,  the  cost  system  begins 
to  drift  away  from  absolute  accuracy.    It  is  in  many  cases 
possible  to  adopt  a  trade  value  for  the  unfinished  product 
of  Q^iven  departments  and  operations  but  this  trade  value 
merely  represents  what  the  concern  would  have  to  pay 
to  get  the  work  done  elsewhere  and  may  correspond  only 
in  a  very  rough  general  way  to  the  actual  cost  in  the  plant 
itself.    Probably  in  a  concern  where  the  process  of  pro- 
duction is  carried  on  upon  a  large  scale  and  where  the  trade 
value  of  goods  is  not  a  satisfactory  guide,  even  approxi- 
mately, to  an  estimate  of  actual  costs,  the  best  results 
can  be  obtained  by  frequently  re-establishing  the  estimated 
unit  cost  of  the  work,  drawing  this  unit  cost  from  the 
records  of  expense  outlays  that  are  indicated  by  the  cost 
sheets  exhibiting  actual  results  in  the  plant.    An  illustra- 
tion of  how  this  system  may  be  applied  in  a  very  large 
concern  which,  however,  works  upon  the  basis  of  separate 
orders,  may  be  seen  in  the  system  adopted  for  the  govern- 
ment printing  office  as  set  forth  on  pages  327,  ff.  of  Part  II 
of  the  present  volume.    Under  such  conditions  as  this,  the 
cost  system  becomes  essentially  statistical  in  its  character 
and  there  may  be  ground  for  doubt  whether  it  is  worth 
while  to  endeavor  to  apply  the  cost  system  as  a  part  of 
the  general  bookkeeping  or  accounting  at  least  in  more 
than  a  very  broad  way.    It  is  undoubtedly  the  case  that, 
particularly  where  the  business  is  very  complex,  as  in  the 
case  of  railroads  for  example,  much  of  the  most  valuable 
cost  data  will  be  obtained  only  by  statistical  analysis 
based  upon  the  accounting  data  that  are  supplied  by  the 
general  accounts  themselves.     A  great  deal  of  the  most 
valuable  information  about  business,  particularly  about 


THE  PRINCIPLES  OF  ACCOUNTING         143 

forms  of  business  which  employ  large  fixed  capital,  cannot 
always  be  put  into  pecuniary  form.  That  is  to  say,  the 
results  of  a  given  operation  cannot  be  stated  in  terms  of 
money.  We  have  already  noted  this  difficulty  in  those 
cases  where  a  purely  fictitious  or  trade  value  is  placed 
upon  the  uncompleted  results  of  given  operations.  In  the 
case  of  such  an  enterprise  as  a  railroad,  for  example,  con- 
clusions as  to  the  business  of  the  road  may  often  be  ob- 
tained in  best  form  from  statistical  analyses  showing  the 
number  of  units  of  a  certain  kind  of  business  performed 
in  a  given  unit  of  time.  Thus  the  records  of  the  road  may 
show  the  amount  expended  for  hauling  freight  of  various 
kinds,  the  distance  traveled,  etc.,  and  the  amount  realized 
from  each  consignment  of  freight.  It  is  not  possible  to  di- 
vide such  items  of  expense  as  the  interest  on  bonds  or  the 
overhead  charges,  such  as  salaries  of  officials,  etc.,  between 
freight  and  passenger  traffic  or  between  the  iron  ore  hauled 
and  the  dry  goods.  An  attempt  to  assign  costs  in  that  way 
would  be  absurd.  A  great  deal,  however,  can  be  learned 
from  statistics  showing  the  number  of  miles  traveled  by 
freight  which  can  be  reduced  to  so-called  ton-miles,  the 
unit  here  being  the  task  of  hauling  a  ton  of  freight  one  mile, 
or  from  a  study  of  passenger  statistics  showing  the  number 
of  passengers  transported  a  given  number  of  miles  which  of 
course  can  be  reduced  to  passenger-miles,  the  unit  here 
being  the  work  of  carrying  a  passenger  one  mile.  By  the 
establishment  of  such  units  of  work  and  by  comparing  the 
number  of  such  units  performed  in  the  course  of,  say,  a 
year,  it  is  practicable  to  draw  conclusions  as  to  the  density 
of  traffic  on  the  road  as  compared  with  general  density  of 
traffic  and  to  ascertain  by  comparison  with  expenses  ar- 
ranged in  large  groups,  the  comparative  cost  of  passenger 
or  freight  traffic,  leaving  the  non-distributable  charges  out 
of  account.  The  aim  of  these  railway  statistics  is  thus  not 
to  determine  costs  so  as  to  gauge  the  margin  of  profit  as 
is  usually  the  case  in  business  cost  accounts.    In  the  highest 


144  HENEY  PARKER  WILLIS 

sense  of  the  term,  statistical  analyses  of  business  opera- 
tions, designed  to  show  unit  costs  or  density  of  business 
per  unit  of  plant  employed  or  capital  invested,  are  **  ac- 
counting." They  may  not  be  based  upon  a  formal  book- 
keeping foundation  or  be  made  to  fit  into  any  scheme  of 
corresponding  double  entries,  but  the  accounting  idea  is 
present.  This  is  the  idea  of  analysis  of  business  and  ap- 
portionment of  results  or  incomes  to  efforts  or  outlays. 

Accounting  Controversies. 

Sharp  controversy  has  raged  for  a  good  while  about 
analyses  of  cost,  different  elements  of  cost,  etc.  Of  course 
the  elements  of  cost  are  the  same  when  considered  in  the 
abstract — labor,  material  and  expense,  including  in  the  lat- 
ter the  cost  of  using  capital,  the  cost  of  obtaining  services 
of  various  kinds,  etc.  But  these  items  are  combined  in  dif- 
ferent ways  and  vary  materially  from  plant  to  plant.  The 
raw  material  of  one  business  is  the  finished  product  of 
another  and  there  may  be  room  for  substantial  doubt  re- 
garding the  assignment  of  a  given  factor  in  production  at 
any  given  time.  Cost  accounting  is  still  undergoing  rapid 
development  and  in  practical  application  it  is  likely  to 
change  very  rapidly  and  very  materially  within  the  next 
few  years.  The  changes  will  be  in  the  direction  of  better 
analysis  of  costs,  better  organization  of  business,  more 
minute  apportionment  of  outlays  and  the  like,  but  the  fund- 
amental principles  at  the  bottom  of  all  cost  accounting  will 
remain  the  same. 

X.    PROFIT  AND  LOSS  ACCOUNTS. 

Relation  of  Profit  and  Loss  to  Business. 

We  have  already  had  something  to  say  with  reference 
to  the  profit  and  loss  account  of  the  ordinary  retail  busi- 
ness. We  there  showed  that  the  determination  of  profits  or 
losses  arising  from  a  given  industrial  operation  or  business 


THE  PRINCIPLES  OP  ACCOUNTING         145 

transaction  was  the  important  end  toward  whicli  the  ac- 
counting of  the  business  was  directed.  Subsequently  we 
also  saw  that  the  profit  and  loss  account  furnishes  the 
information  necessary  for  use  in  completing  capital  ac- 
count and  for  showing  whether  capital  has  been  increased 
or  impaired.  Wliile  in  ordinary  business  the  technique  of 
profit  and  loss  accounting  is  comparatively  simple,  increas- 
ing complexity  in  business  operations  raises  two  points  of 
very  serious  difficulty  and  importance:  (1)  How  to  allo- 
cate, so  far  as  possible,  profits  and  losses ;  or,  what  is  much 
the  same  thing,  how  to  divide  the  profit  and  loss  account  so 
as  to  show  the  distribution  of  profits  in  the  gross,  and  (2) 
how  to  represent  in  a  correct  way  a  given  outlay  as  provid- 
ing a  permanent  addition  to  the  business,  or  as  constituting 
an  actual  expense  which  is  a  loss  since  it  does  not  provide 
any  element  of  future  strength  for  the  business  but  merely 
liquidates  a  liability  which  has  already  accrued.  The  gen- 
eral question  of  profit  and  loss  account  may  now  be  re- 
viewed at  some  length  analytically  and  in  the  light  of  the 
studies  already  made  of  other  accounts. 

General  Profit  and  Loss  Account. 

In  dealing  with  the  question  at  the  outset,  we  saw  that 
general  profit  and  loss  account  in  a  retail  business  consists 
on  the  debit  side  of  a  series  of  entries  of  expense 
or  outlay  and  on  the  credit  side  of  a  series  of  entries 
representing  incomes,  the  chief  entry  there  being  the 
gross  profit  realized  on  goods.  Later  on  we  saw  that 
for  the  purpose  of  getting  a  general  idea  of  condi- 
tions in  some  one  branch  of  a  given  business,  as,  for 
example,  in  a  given  class  of  goods  in  a  retail  business, 
it  may  be  deemed  wise  to  enter  some  elements  of  ex- 
pense along  with  goods  as  a  means  of  assigning  those  par- 
ticular expenses  to  that  particular  department,  thus  estab- 
lishing what  was  called  a  "trading  account."  In  the  latter 
case,  it  was  seen,  there  is  left  for  entry  as  debits  in  the 

B— VIII— 10 


146  HENRY  PARKER  WILLIS 

profit  and  loss  account  properly  so-called,  only  the  general 
expenses  of  the  business  which  are  not  capable  of  allocation 
or  which  it  is  not  deemed  wise  to  try  to  distribute.  In  both 
of  these  cases,  an  extremely  simple  form  of  profit  and  loss 
account  is  presented.  In  the  first  we  have  as  debits  such 
simple  items  as  elements  of  expense  of  a  representative 
kind  like  rent,  fuel,  light,  discounts,  etc.,  while  our  credits 
were  simply  the  obvious  gain  on  goods  sold.  In  the  latter 
case  (where  a  trading  account  was  employed)  we  simjjly 
had  a  few  of  the  special  expenses  assigned  to  the  depart- 
ments where  they  were  incurred,  and  then  in  the  profit  and 
loss  account  in  general  we  retained  on  the  debit  side  the 
general  representative  expenses,  and  the  gross  profits  on 
the  credit  side. 

Sections  of  Profit  and  Loss. 

Clearly  such  a  profit  and  loss  account  is  unsatisfactory 
for  two  reasons:  (1)  It  fails  (even  where  some  trading 
accounts  are  kept)  to  distribute  profits  and  losses  among 
the  different  branches  of  business,  and  (2)  it  fails  to  show 
what  use  has  been  made  of  profits.  This  may  be  a  very 
serious  defect  in  a  business  of  any  degree  of  complexity. 
The  difficulties  objected  to  can  be  overcome  by  segregating 
profit  and  loss  into  several  sections.  What  shall  these 
sections  be?  It  was  suggested  at  an  earlier  point,  that  the 
sectional  division  adopted  might  be  one  based  simply  upon 
the  establishment  of  an  account  for  each  of  the  elements 
of  expense  entering  into  profit  and  loss.  Thus  for  example 
we  might  open  accounts  with  "Rent,"  ''Wages,"  "Fuel," 
"Discount,"  etc.,  finally  closing  them  all  into  profit  and 
loss  which  is  thus  a  summary.  If  the  business  conducts  a 
number  of  different  departments,  each  with  a  trading  ac- 
count of  its  own,  these  will  be  closed  into  profit  and  loss  in 
the  same  way,  the  gross  profits  appearing  on  the  credit 
side,  in  which  case  profit  and  loss  is  simply  a  summary 
statement  of  the  "sections"  or  trading  accounts  which  are 


THE  PRINCIPLES  OF  ACCOUNTING         147 

constituted  of  the  different  expense  items  (debits)  and  the 
different  income  items  (credits),  and  which  show  gross  pro- 
fits. This,  however,  is  not  a  complete  way  of  dealing  \vith 
the  situation.  The  summarized  profit  and  loss  account 
which  has  been  thus  described  may  be  itself  divided  into 
sub-sections.  For  a  retail  business  the  first  section  which 
it  is  desirable  to  recognize  is  that  of  trading  operations.  In 
this  case  total  sales  would  be  credited  after  deducting  trade 
discounts  and  returns,  such  credit  either  representing  the 
total  sales  in  all  departments  or,  if  desired,  the  sales  classi- 
fied by  departments.  The  debit  side  of  such  a  first  section 
would  as  usual  show  the  cost  of  the  goods  disposed  of, 
amounts  paid  for  freights,  discounts  allowed,  etc.,  as  well 
as  all  outlays  directly  growing  out  of  the  selling  process. 
By  keeping  in  this  first  section  of  profit  and  loss  the  gross 
results  of  the  departmental  business  on  the  one  side  and 
the  gross  actual  trade  expenses  connected  with  the  actual 
selling  process  of  those  departments  on  the  other,  the  first 
section  of  profit  and  loss  account  is  made  to  show  the  total 
gross  profits  realized  in  all  departments.  This  may  now  be 
totaled  and  the  balance  of  gross  profit  may  be  carried 
down  on  the  credit  side.  The  second  section  of  profit  and 
loss  now  may  be  developed.  It  is  immediately  opened 
with  a  credit  entry  representing  gross  profit  as  ascer- 
tained from  the  first  section.  Other  items  of  income  may 
now  be  credited  representing  such  sources  of  revenue  as 
did  not  grow  directly  out  of  selling  operations.  For  ex- 
ample, if  the  concern  has  leased  a  certain  part  of  its  prem- 
ises to  others  there  will  be  income  in  the  shape  of  rent  for 
this  lease.  Thi*s  will  now  be  credited  along  with  any  other 
revenue  items  that  are  derived  from  a  non-trading  source. 
The  debit  entries  in  this  section  will  be  those  which  do  not 
grow  out  of  actual  selling  operations.  Examples  would  be 
fixed  rent  paid,  general  salaries  and  the  like,  as  well  as 
business  losses,  bad  debts,  etc.  By  balancing  this  part 
of  profit  and  loss,  we  shall  obtain  a  result  which  will  show 


148  HENRY  PARKER  WILLIS 

the  actual  business  profit  free  of  all  ordinary  costs  or  out- 
lays involved  in  tlie  general  management  of  the  business. 
There  may,  however,  be  other  deductions  to  be  made  be- 
fore we  are  able  to  recognize  the  profit  apparently  shown 
by  the  business  as  a  true  net  profit.  A  third  section  of  the 
account  may,  therefore,  be  opened  and  to  this  the  term  "net 
profit  account"  may  be  assigned.  This  is  opened  with  a 
credit  entry  representing  the  ordinary  profit  shown  in 
the  preceding  section,  and  there  will  also  be  credited  in- 
comes that  are  directly  connected  with  capital,  such  as  the 
results  of  investments  that  may  have  been  made,  interest 
earned,  discounts  obtained,  etc.  On  the  debit  side,  will  be 
entered  all  those  outlays  growing  out  of,  or  depending  up- 
on, the  use  of  capital,  chief  among  which  will  be  the  inter- 
est on  loans  and  the  like.  The  balance  of  this  section  gives 
the  net  profit  realized  by  the  concern  and  represents  what 
the  business  has  left  after  paying  (a)  its  actual  selling 
expenses  not  allocated  in  the  various  trading  accounts;  (b) 
its  business  expenses,  taxes,  overhead  charges,  losses,  and 
the  like;  and  (c)  the  cost  of  keeping  borrowed  capital  at 
work  and  other  expenses  connected  with  capital.  Still  the 
account  as  thus  balanced  does  not  show  what  distribution 
has  been  made  of  the  net  profit  exhibited.  As  we  saw  in 
our  foregoing  treatment  (see  p.  92),  it  may  be,  in  many 
cases,  will  be,  desired  to  set  apart  some  portion  of  the  pro- 
fits for  the  purpose  of  establishing  a  reserve  or  a  fund  for 
depreciation,  or  for  other  purposes.  Moreover  it  may  be 
desirable,  if  the  business  is  a  partnership,  to  show  distinct- 
ly how  the  distribution  has  been  made  among  the  partners, 
or  if  it  is  a  corporation  how  the  distribution  of  net  profit 
has  been  made  between  the  different  classes  of  stock.  This 
final  section  of  profit  and  loss  account  may  be  called  '^pro- 
fit and  loss  appropriation  account."  It  will  be  opened  on 
the  credit  side  with  the  total  net  undistributed  profit  shown 
by  the  preceding  section  and  there  will  be  no  further  credit 
entries.    The  debit  entries  will  show^  the  distribution  as  be- 


THE  PRINCIPLES  OF  ACCOUNTING 


149 


tween  different  sharers  in  the  profit,  reserve,  undivided 
profits,  etc.  To  make  this  whole  method  clearer  we  may; 
present  the  following  illustration  of  such  a  subdivided  pro- 
fit and  loss  account  as  is  here  contemplated.* 


PROFIT  AND  LOSS  ACCOUNT. 


Expenditure. 

Income. 

To    cost    of   goods    less    dis- 

By gross  sales  less  trade  dis- 

counts, 

counts, 

"    outlay    involved    in    sell- 

ing goods,   including  com- 

missions     and      expenses, 

wages  of  clerks  and  others, 

freights  and  expenses,  cash 

discounts. 

"   balance   carried   down  as 

gross,  profit 

To  fixed  expenses,  including. 

Rent,    taxes,    etc.. 

By  balance  brought  down  as 

Repairs  and  running  office 

gross  profit. 

costs, 

"   income  not  due  to  selling 

Overhead   charges   in  gen- 

such as. 

eral, 

Rents, 

Depreciation, 

Income  from  other  outside 

"    business    losses,   such   as 

sources. 

Bad  debts. 

Defalcations, 

"   balance   carried  down  as 

By  balance  brought  down  as 

profit  on  ordinary  business, 

ordinary  business  profit. 

"income  from  use  of  cap- 

To expenses  in  getting  cap- 

ital,   such    as. 

ital,  such  as 

Income  from  investments. 

Interest  on  bonds  or  loans. 

Interest  earned, 

"    balance   carried    down   as 

Cash  discounts  secured  (of 

net  profit, 

certain  classes). 

To  allocation  of  profit. 

By  balance  of  net  profit 

Interest  on  capital, 

brought  down, 

Profit   assigned   to   capital, 

Profit     segregated    as    re- 

serve. 

"   profit  undivided  and  car- 

. 

ried  forward. 

♦See  Lisle:  Accounting  in  Theory  and  Practice,  pp.  57,  iff. 


150  HENRY  PARKER  WILLIS 

Uses  of  Profit  and  Loss  Account. 

What  has  been  said  indicates  the  main  purpose  of  the 
profit  and  loss  account  and  suggests  the  ideas  and  char- 
acter of  information  which  can  be  obtained  from  an  analy- 
sis of  a  carefully  kept  profit  and  loss  statement  by  a  stu- 
dent who  wishes  to  find  out  what  the  concern  has  been  do- 
ing. The  profit  and  loss  account,  if  kept  in  the  way  already 
indicated,  will  show  the  amount  of  the  operations  of  the 
business  as  a  whole  as  well  as  the  amount  of  the  operations 
of  the  various  departments  considered.  But,  in  addition, 
it  will  also  show  the  total  amount  of  expenditure  and  the 
amount  of  expenditure  in  each  several  department  result- 
ing from  the  given  volume  of  operations.  From  this  can  be 
inferred,  as  already  indicated,  the  gross  profit  which  is 
realized  on  the  selling  branches  of  the  business.  It  is, 
moreover,  possible  to  compare  the  overhead  charges  which 
are  necessary  by  reason  of  the  method  of  organization  of 
the  business,  the  amount  of  the  salaries  of  its  officers,  the 
cost  of  its  general  expenses  due  to  the  payment  of  rent, 
and  the  like.  These  can  be  contrasted  with  the  volume  of 
business  that  is  being  done  and  the  profits  that  are  being 
earned  in  consequence.  From  this,  it  is  possible  to  deduce 
a  definite  idea  as  to  the  relation  of  general  management 
expenses  to  the  total  operations  and  to  recognize  a  condi- 
tion, should  it  arise,  where  too  much  is  being  expended  up- 
on general  management  as  compared  with  the  actual  prac- 
tical operations  of  the  enterprise.  From  such  a  profit  and 
loss  account,  too,  it  can  be  seen  how  far  the  concern  has 
lost  through  unforeseen  conditions  or  through  conditions 
which  were  not  due  to  slack  sales  but  to  bad  judgment,  such 
as  in  trusting,  or  giving  credit  to,  the  wrong  person.  The 
final  section  of  the  account  shows  what  proportion  is  borne 
by  fixed  charges,  reserves,  etc.,  to  the  total  net  profit, 
if  any,  and  this,  of  course,  suggests  the  conclusions  or  infer- 
ences which  are  unavoidably  to  be  drawn  from  the  show- 


THE  PRINCIPLES  OF  ACCOUNTING         151 

ing  made  with  reference  to  the  relation  of  the  fixed  charges 
to  the  general  net  income  realized  on  the  capital,  whether 
that  capital  be  borrowed  or  directly  placed  in  the  business 
by  the  shareholders  or  partners.  Thus  it  is  possible  to 
analyze  the  condition  of  the  concern  from  a  large  general 
standpoint.  This  would  not  have  been  possible  in  a  pro- 
fit and  loss  account,  however  accurate,  where  no  distinc- 
tion was  made  between  the  different  sources  or  kinds  of 
profit  and  the  different  sources  or  kinds  of  income  and 
where  no  effort  was  made  to  compare  those  sources  or 
kinds  of  profit  or  income  with  the  sources  or  kinds  of  ex- 
pense or  loss  that  were  directly  and  intimately  associated 
with  them  or  that  were  due  to  the  same  broad  conditions. 
The  general  principle  which  we  have  pursued  in  sub-divid- 
ing profit  and  loss  account  has  been  merely  that  of  analy- 
sis, elements  of  profit  and  loss  arising  from  the  same  con- 
ditions being  grouped  together  in  one  section  of  the  account 
on  the  credit  and  debit  sides  respectively,  the  balance  there 
exhibited  being  then  transferred  to  the  next  section  as  an 
opening  credit  (or  debit,  if  the  outlay  exceeds  the  income). 

Income  and  Expenditure. 

It  is  clear  that  in  thus  analyzing  profit  and  loss  account 
we  have  substantially  abandoned  the  narrow  conception  of 
** Profit"  and  *'Loss"  although  we  may  find  it  convenient 
to  retain  these  conventional  names.  What  we  have  done 
has  been  to  substitute  an  analysis  or  grouping  of  incomes 
and  outgoes.  The  profit  and  loss  account  is  thus  seen  to  be 
really  an  income  account  in  some  of  its  aspects.  The  term 
** Income  Account"  is  by  some  reserved  for  the  section  of 
profit  and  loss  which  we  termed  ''Net  Profit  Account"  and 
sometimes  for  a  combination  of  that  and  the  preceding 
business  profit  account  or  section  (the  second  of  those 
enumerated  above  on  p.  147) .  It  is  obvious  that  in  dividing 
incomes  and  expenditures  among  these  various  sections  it 
may  be  difficult  to  tell  in  any  given  case  whether  a  speci- 


152  HENRY  PARKER  WILLIS 

fied  outlay  of  money  belongs  in  one  section  or  in  the  other. 
This  difficulty  will  arise  because  it  is  not  possible  in  every 
case  to  know  the  precise  purpose  for  which  the  expenditure 
is  made  and  consequently  the  precise  effect  it  will  have.  In 
the  same  way  it  may  be  difficult  to  determine  definitely 
whether  a  given  income  is  assignable  to  one  or  the  other 
section.  It  may  be  said  in  general  that  all  incomes  and 
expenditures  may  be  divided  into  two  classes — capital  in- 
come and  capital  expenditure,  and  revenue  income  and 
revenue  expenditure.  This  idea  needs,  however,  some 
further  elucidation.  Suppose  that  a  concern  has  started 
business  with  a  given  amount  of  invested  capital,  say 
$8,000.  It  may  be  supposed  that  $2,000  of  this  is  invested 
in  real  estate,  $1,000  in  fixtures  and  plant,  and  the  rest 
in  goods.  Now  if  in  the  course  of  the  year  an  addition 
be  made  to  the  real  estate  or  building  in  which  the 
concern  is  located  costing,  say,  $500,  this  being  paid 
out  of  the  regular  incomes,  it  is  evident  that  the  ^*  ex- 
pense" or  **loss"  thus  incurred  is  not  a  ^4oss"  in 
the  sense  that  it  is  a  sacrifice  of  the  amount  spent. 
The  amount  expended  constitutes  an  additional  in- 
vestment. Supposedly  it  would  be  credited  to  cash  and 
debited,  perhaps,  to  a  betterments  and  improvements  ac- 
count. It  would  in  that  case  appear  on  the  debit  side  of 
profit  and  loss  account,  being  presumably  assigned  to  the 
section  of  profit  and  loss  which  deals  with  the  expenditures 
and  incomes  distinctly  relating  to  capital  (the  third  sec- 
tion in  the  analysis  made  on  p.  148).  This  would  be  an  actu- 
al outlay  of  cash,  and  as  such,  would  constitute  a  deduction 
from  total  revenue  since  it  is  paid  out  of  total  revenue. 
Clearly,  however,  such  a  showing  would  not  tell  the  whole 
story,  inasmuch  as  there  would  be  no  indication  of  the  ex- 
istence of  an  item  of  capital  or  permanent  investment 
growing  out  of  the  transaction.  Unless,  therefore,  there 
were  a  credit  entry  showing  an  increase  in  assets  of  the 
value  of  the  amount  invested,  the  account  would  be  incom- 


THE  PRINCIPLES  OF  ACCOUNTINa         153 

plete.  If  this  outlay  had  been  directly  credited  to  capital 
in  the  first  place  as  it  might  have  been  where  an  individual 
was  carrying  on  business  alone,  or  to  surplus  (practically  a 
section  of  capital  account)  where  the  concern  was  a  corpor- 
ation; there  would  have  been  as  before  a  credit  in  cash  and 
a  debit  to  betterments.  This  would  now  be  supplemented 
by  the  credit  to  reserve  and  a  debit  to  the  particular  asset 
account  concerned — in  this  instance,  real  estate.  In  that 
case  the  object  of  truthfulness  would  have  been  fully  at- 
tained since  it  would  have  been  shown  that  there  was  an 
increase  in  the  capital  assets  of  the  concern  of  $500  and  a 
decrease  in  the  floating  cash  on  hand  of  $500.  The  profit 
side  of  profit  and  loss  would  not  have  been  brought  into 
the  transaction  and  perhaps  need  not  have  been.  It  is, 
however,  plain  that  such  an  arrangement  of  the  entries 
would  not  have  given  the  whole  data.  Inspection  of  the 
profit  and  loss  account  would  have  revealed  nothing  about 
the  transaction  to  one  who  merely  looked  at  profit  and  loss 
and  at  nothing  else.  If  the  credit  entry  is  made  in  cash 
when  cash  is  paid  out  a  corresponding  debit  being 
assigned  to  ''betterments  and  improvements" — and  if 
at  the  end  of  the  year  or  other  fiscal  period  the  debit 
balance  in  betterments  and  improvements  be  trans- 
ferred to  the  debit  side  of  profit  and  loss  as  a  loss, 
the  account  will  merely  show  that  there  has  been  an  item 
of  outlay  or  loss  which  has  been  incurred  for  the  purpose 
of  enlarging  or  improving  certain  fixed  assets.  Yet  the  in- 
creased assets  are  actually  a  gain  to  the  business  and  cor- 
responding credit  entry  in  profit  and  loss  to  represent  such 
an  addition  to  wealth  could  be  secured  only  by  crediting 
an  account  with  the  amount  of  assets  or  cash  which  it  sup- 
plies to  the  business  as  we  did  in  the  case  of  ''reserve"  and 
then  taking  this  up  upon  the  credit  side  of  that  section  of 
the  profit  and  loss  account  which  represents  the  outlaj^s 
and  incomes  connected  with  capital.  In  that  event  the  pro- 
fit and  loss  account  would  show  that  there  had  been  an  in- 


154  HENRY  PARKER  WILLIS 

come  of  assets  received  by  the  concern  and  an  outlay  of 
cash  on  improvements.  In  the  last  analysis,  in  such  a  case, 
profit  and  loss  would  show  a  profit  w^hich  was  partly  made 
up  of  cash  and  partly  of  fixed  assets  that  had  come  into  the 
possession  of  the  concern  and  it  would  show  a  loss  that  was 
partly  composed  of  outlay  for  running  expenses  and  partly 
of  outlays  for  the  purchase  of  the  new  fixed  capital.  In 
this  case  by  carrying  the  transaction  through  profit  and 
loss  it  would  be  shown  that  there  had  been  an  outlay  of  in- 
come in  the  form  of  additions  to  fixed  capital.  The  income 
statement,  really  a  more  detailed  description  of  profit  and 
loss,  would  show  the  destination  of  income  and  the  use 
made  of  it,  as  well  as  the  fact  that  this  income  was  on  hand 
in  a  fixed  form.  Wliile  this  system  might  be  theoretically 
correct,  it  is  customarily  desirable  to  have  the  profit  and 
loss  account  deal  only  with  cash  incomes  and  cash  outlays. 
If,  therefore,  upon  spending  cash  for  the  improvement  al- 
ready referred  to,  cash  account  is  credited,  betterments  ac- 
count is  debited,  the  transfer  of  this  debit  is  made  to  profit 
and  loss  and  nothing  is  said  of  the  growth  of  the  assets,  the 
profit  and  loss  statement  will  show  that  income  has  been  ex- 
pended in  the  way  indicated  while,  by  crediting  capital 
or  reserve  with  the  value  of  improvements  made  and 
debiting  the  corresponding  real  account,  the  fact  that  cap- 
ital has  been  enlarged  to  that  extent  is  sufficiently  indicat- 
ed. This  case  is  clear  enough  in  so  far  as  concerns  the 
nature  of  the  outlay.  But  there  are  many  cases  in  which 
the  nature  of  an  outlay  is  not  so  easily  determinable.  For 
instance,  if  in  the  case  cited,  the  outlay  had  been  made  for 
the  purpose  of  putting  a  new  roof  upon  the  building  oc- 
cupied by  the  concern,  it  might  fairly  be  questioned  wheth- 
er this  was  an  addition  to  fixed  capital  or  whether  it  was 
simply  a  restoration  of  capital  that  had  become  worn  out, 
the  cost  of  the  restoration  being  in  that  case  obviously  a 
real  loss  or  cost  of  doing  business.  If  in  such  a  case  repairs 
account  was  debited  and  cash  credited,  repairs  would  prop- 


IN(  (),\\1-    ACCOUNT 


Operating  Income  . 

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0|v,.ilii,-  Rcvi'iiiK';,- 

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Other  Income 

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trolled— 

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Miscellaneous  Income— 

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Total  Other  Income., 

Gross  Corporate  Income  earned  foru  ird. 

Gross  Corporate  Loss  carried  forward, 

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Gross  Corporate  Loss  brought  forward, 

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DEDUCTIONS  FROm  GROSS  CORPORATE  INCOME: 

Renis  Accnii'd  lur  Leasi-  of  Other  Roads- 

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(a)  Hire  of  Equipment— Balance— 

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Separately  Operated  Properties— Loss- 

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Sinking  and  Redemption  Funds  Ch.irfie.ible to  Incomi-, 

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Net  Corporate  Income, 

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Disposition  of  net  Corporate  Income: 

Dividends  Declared- 

fa)  On  Common  Stock— 

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per  cent  payable 

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per  cent  payable 

(*)  On  Preferred  Stock— 

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per  cent  payable 

per  cent  paj'able 

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Appropriations  for  Additions  and  Betterments: 

- 

(a)  Expended  During  the  Year, 

(A)   Held  in  Reserve, 

Appropriations  for  New  Lines  or  Extensions. 

(a)  Expended  During  the  Year, 

(b)  Held  in  Reserve, 

Appropriations  for  Other  Reserves, 

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Balance  for  Year  Carried  Forward 

TO                    Of  Profit  and  Loss, 



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THE  PEINCIPLES  OF  ACCOUNTINa         155 

erly  be  closed  into  profit  and  loss  without  any  other  ac- 
counting, and  it  would  be  seen  that  a  part  of  the  expense 
or  outlay  of  the  concern  had  been  for  the  purpose  of  main- 
taining capital  in  as  good  a  shape  as  it  was  at  the  start. 
The  question  whether  to  regard  a  given  outlay  as  intended 
for  the  purpose  of  and  actually  accomplishing,  an  enlarge- 
ment of  the  capital  assets,  or  to  treat  it  as  actually  an  out- 
lay for  running  expenses  is  always  difficult  in  any  business 
where  the  question  of  depreciation  enters  in.  Thus  in  con- 
cerns employing  machinery  very  largely  a  certain  expense 
of  maintenance  has  to  be  met  each  year  and  it  is  always  an 
open  question  how  far  repairs  on  such  machines  are  actu- 
ally an  element  in  the  necessary  and  unavoidable  cost  of 
operating  them  and  how  far  they  are  correctly  regarded  as 
a  provision  against  depreciation,  tantamount  to  an  in- 
crease of  capital  as  compared  with  the  situation  which 
would  have  existed  had  there  been  no  such  provision  for 
upkeep. 

Income  Sheet  of  a  Railroad. 

The  foregoing  principles  may  be  illustrated  to  an  extent 
by  considering  the  income  statement  for  railroads  suggest- 
ed by  the  Interstate  Commerce  Commission  as  properly  the 
one  to  be  employed  in  reporting  conditions  for  a  fiscal  per- 
iod. This  income  statement  may  be  regarded  as  in  a  true 
sense  a  representation  of  a  profit  and  loss  account  in  a 
different  form,  the  debit  entries  and  credit  entries  not  be- 
ing arranged  on  opposite  sides  of  the  page  or  in  the  con- 
ventional way  which  is  demanded  by  accounting.  It  will 
be  seen  from  the  form  herewith  presented,  that 
the  income  statement  gives  substantially  all  the  items  al- 
ready referred  to.  There  are  shown  the  gross  operating 
revenues,  operating  expenses  which  correspond  to  the  bal- 
ances of  the  trading  section  of  profit  and  loss  account. 
Then  are  given  the  results  of  rentals  and  other  sources  of 
income  both  actually  realized  and  accrued,  as  well  as  the 


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THE  PRINCIPLES  OF  ACCOUNTINa         155 

erly  be  closed  into  profit  and  loss  without  any  other  ac- 
counting, and  it  would  be  seen  that  a  part  of  the  expense 
or  outlay  of  the  concern  had  been  for  the  purpose  of  main- 
taining capital  in  as  good  a  shape  as  it  w^as  at  the  start. 
The  question  whether  to  regard  a  given  outlay  as  intended 
for  the  purpose  of  and  actually  accomplishing,  an  enlarge- 
ment of  the  capital  assets,  or  to  treat  it  as  actually  an  out- 
lay for  running  expenses  is  always  difficult  in  any  business 
where  the  question  of  depreciation  enters  in.  Thus  in  con- 
cerns employing  machinery  very  largely  a  certain  expense 
of  maintenance  has  to  be  met  each  year  and  it  is  always  an 
open  question  how  far  repairs  on  such  machines  are  actu- 
ally an  element  in  the  necessary  and  unavoidable  cost  of 
operating  them  and  how  far  they  are  correctly  regarded  as 
a  provision  against  depreciation,  tantamount  to  an  in- 
crease of  capital  as  compared  with  the  situation  which 
would  have  existed  had  there  been  no  such  provision  for 
upkeep. 

Income  Sheet  of  a  Railroad. 

The  foregoing  principles  may  be  illustrated  to  an  extent 
by  considering  the  income  statement  for  railroads  suggest- 
ed by  the  Interstate  Commerce  Commission  as  properly  the 
one  to  be  employed  in  reporting  conditions  for  a  fiscal  per- 
iod. This  income  statement  may  be  regarded  as  in  a  true 
sense  a  representation  of  a  profit  and  loss  account  in  a 
different  form,  the  debit  entries  and  credit  entries  not  be- 
ing arranged  on  opposite  sides  of  the  page  or  in  the  con- 
ventional way  which  is  demanded  by  accounting.  It  will 
be  seen  from  the  form  herewith  presented,  that 
the  income  statement  gives  substantially  all  the  items  al- 
ready referred  to.  There  are  shown  the  gross  operating 
revenues,  operating  expenses  which  correspond  to  the  bal- 
ances of  the  trading  section  of  profit  and  loss  account. 
Then  are  given  the  results  of  rentals  and  other  sources  of 
income  both  actually  realized  and  accrued,  as  well  as  the 


156  HENRY  PARKER  WILLIS 

incomes  earned  from  investments — these  corresj5onding  to 
credit  entries  in  the  second  and  third  sections  of  profit  and 
loss  account  as  above  given.  The  debit  entries  are  seen 
in  the  showing  made  with  reference  to  outlay  on  these  same 
general  accounts,  while  what  corresponds  to  the  appor- 
tionment (the  last  section  of  profit  and  loss  as  above  an- 
alyzed), is  shown  in  the  statement  of  Interest  Accrued, 
Sinking  Fund  Charges,  Dividends  Declared,  etc.  This  af- 
fords all  of  the  items  of  information  already  referred  to 
although  the  formal  grouping  is  not  put  into  the  technical 
shape  demanded  by  accountancy. 

Business  Results. 

It  is  clear  that  the  profit  and  loss  statement  or  income 
sheet  will  not  show  the  business  results  of  the  concern  in 
any  satisfactory  way  unless  all  of  the  entries  have  been 
made  upon  a  basis  of  good  judgment  and  unless  every  item 
of  income  and  expenditure  has  been  included.  The  show- 
ing of  profit  and  loss  will  be  incomplete  and  unsatisfactory 
unless  there  is  some  allowance  for  such  items  as  Depreci- 
ation, Reserves,  etc.,  intended  to  cover  the  actual  wearing 
away  of  fixed  assets  and  the  provision  for  the  losses  which 
are  certain  to  fall  upon  a  concern  in  realizing  upon  its  as- 
sets no  matter  how  conservatively  they  may  have  been 
valued.  Some  personal  accounts  will  always  turn  out  to 
be  bad  and  many  fixed  assets  if  sold  will  realize  less  than 
the  amount  at  which  they  were  originally  bought  and  fre- 
quently less  than  the  amount  at  which  they  were  carried 
on  the  books.  Profit  and  loss  account,  then,  shows  the  true 
result  of  the  operations  for  the  year  or  other  fiscal  period 
only  after  due  allowance  has  been  made  not  only  for  all 
elements  of  income  and  outlay  in  the  form  of  cash,  but  after 
proper  allowance  has  been  made  for  all  incomes  and  out- 
goes that  take  the  form  of  increases  or  decreases  in  own- 
ership and  value.  When  this  has  been  done,  the  balance 
of  profit  and  loss  shows  the  net  increase  in  value  that  has 


THE  PRINCIPLES  OF  ACCOUNTINa         157 

occurred  during  the  year  and  consequently  the  state  of 
the  assets  and  liabilities  as  affected  by  the  operations  of 
the  year.  Clearly,  too,  the  results  will  be  correctly  shown 
only  in  the  event  that  there  has  been  an  accurate  taking  of 
stock.  For  instance,  in  the  retail  business  concern,  we  saw 
that  to  close  goods  account  it  is  necessary  in  the  first  place 
to  have  a  careful  inventory,  or  in  some  way  to  ascertain  the 
value  of  the  goods  on  hand,  otherwise  the  results  would  be 
incomplete  and  would  not  admit  of  comparison  because 
they  would  not  show  w^here  the  concern  stood.  The  same 
thing  is  true  of  fixed  capital.  It  is  not  possible  to  tell  what 
the  result  of  a  year's  operation  has  been  unless  recognition 
is  made  of  the  fact  of  depreciation,  or,  what  amounts  to  the 
same  thing,  physical  assets  are  revalued.  Such  revaluation 
of  physical  assets  is  equivalent  to  the  stock-taking  process. 
If  there  were  a  revaluation  of  such  assets  at  the  end  of 
each  year  or  other  fiscal  period  before  writing  up  profit  and 
loss  account  and  if  depreciation  had  occurred  as  it  usually 
would,  this  would  mean  a  debit  entry  in  profit  and  loss 
corresponding  to  depreciation.  The  consequence  would  be 
that  net  profit  would  be  reduced  to  a  corresponding  extent. 
The  same  result  is  attained  when,  after  ascertaining  what 
is  called  net  profit,  an  allocation  of  such  profit  is  made  by 
debiting  in  profit  and  loss  account  an  entry  representing  the 
amount  set  aside  for  depreciation,  depreciation  account  be- 
ing thereupon  similarly  credited.  If  a  credit  entry  be  now 
made  in  eacla  of  the  assets  or  plant  accounts  to  show  the 
amount  of  reduction  in  the  value  of  assets  estimated  to 
have  taken  place  in  the  course  of  the  year,  depreciation  will 
be  debited.  So  also  in  the  case  of  the  inventory  the  ques- 
tion of  accuracy  in  profit  and  loss  will  be  sharply  affected 
by  the  method  adopted  in  valuing  the  goods.  If,  for  ex- 
ample, an  old  stock  is  carried  along  on  the  books  (and  in 
the  inventory)  at  the  cost  price  originally  paid  for  it,  when 
as  a  matter  of  fact  it  has  depreciated  a  good  deal  owing  to 
change  of  style  or  fashion,  this  merely  means  that  an  ele- 


158  HENRY  PARKER  WILLIS 

ment  of  loss  in  the  business  has  been  concealed  and  that 
profit  and  loss  account  has  not  been  conducted  in  such  a 
way  as  to  make  an  accurate  showing  of  the  results  of  the 
business.  Here  we  have  another  example  of  depreciation, 
exhibiting  itself  in  the  case  of  goods  where  no  provision 
is  made  for  recognizing  their  deterioration  in  selling  power 
or  capacity  to  command  money. 

Profit  and  Loss  Analysis. 

Ifrom  what  has  been  said  it  will  be  understood  that  the 
showing  made  by  profit  and  loss  account  is  at  all  times  a  rel- 
atiA^e  matter.    Profit  and  loss,  as  has  been  seen,  may  or  may 
not  take  account  of  depreciation;  it  may  or  may  not  take 
account  of  appreciation;  it  may  or  may  not  represent  an 
accretion  of  new  forms  of  wealth  represented  by  additional 
assets  purchased  out  of  current  incomes.    Whether  profit 
and  loss  shows  anything  definite  or  not  depends  upon  the 
way  in  which  it  has  been  made  up.    It  may  show  nothing 
more  than  the  actual  surplus  of  current  cash  income  over 
current  cash  outgo.    Or  it  may  show  the  difference  between 
the  changes  that  have  taken  place  in  the  direction  of  great- 
er ownership  over  those  that  have  taken  place  in  the  direc- 
tion of  reduced  o^vnership.    For  example,  a  concern  organ- 
ized to  exploit  a  valuable  patent  or  franchise  which  had  a 
definite  number  of  years  to  run  and  which  had  been  paid 
for  in  a  lump  sum  might  show  very  large  profits  from  year 
to  year  resulting  from  actual  operation  and  yet  might  be 
found  to  be  a  losing  business  when  the  gross  profit  made 
was  reduced  by  deducting  an  amount  corresponding  to  the 
fact  that  a  year's  life  of  the  franchise  or  privilege  had  dis- 
appeared.   The  alternative  tha?  is  offered  in  making  up 
a  profit  and  loss  account  is  at  all  events  obvious.    It  may  be 
made  to  include  simply  cash  or  liquid  incomes  and  outaroes 
or  it  may  be  made  to  include  additions  to  and  deductions 
from  capital.    If  it  is  the  former  then  the  changes  in  the 
value  of  capital  do  not  figure  in  profit  and  loss  but  go  ul- 


THE  PRINCIPLES  OF  ACCOUNTING         159 

timately  to  capital  account  through  revahiation  of  assets 
or  otherwise.  It  cannot  be  said  that  there  is  a  definite  de- 
termination as  to  the  attitude  to  be  taken  by  a  business  on 
this  question  in  organizing  its  accounting  and  in  making 
its  profit  and  loss  showing.  This  is  why  the  auditor  or  ex- 
aminer who  is  going  through  the  books  of  a  concern  always 
studies  profit  and  loss  with  particular  care  in  order  to 
make  up  his  mind  as  to  the  way  in  which  the  account  has 
been  constructed.  If  it  has  been  constructed  in  a  certain 
way,  a  given  kind  and  scope  of  additional  information  may 
be  needed.  In  another  way,  the  nature  of  the  additional 
data  would  be  different.  A  profit  and  loss  account  carried 
on  so  as  to  show  simply  the  increase  in  cash  means, 
due  to  the  selling  of  goods  for  more  than  their  cost,  deduct- 
ing the  selling  cost,  has  to  be  supplemented  by  an  accurate 
statement  of  the  remaining  value  of  goods  on  hand,  or,  if 
the  plant  is  one  which  employs  fixed  capital,  it  must  be  sup- 
plemented by  a  statement  showing  changes  in  the  value  of 
such  fixed  capital,«or  if  the  concern  has  sold  goods  on  credit 
for  sums  that  are  not  collectible,  thus  giving  rise  to  bad 
debts,  that  fact  must  be  noted.  The  question  whether  a 
profit  is  actually  available  for  distribution  is  thus  a  very 
serious  one,  not  only  in  an  accounting  sense  but  also  in  the 
broader  economic  sense  which  imderlies  accounting.  The 
subject  has  been  dealt  with  extensively  by  the  courts  both 
in  England  and  the  United  States  but  it  cannot  be  said 
that  there  is  thus  far  any  definite  consensus  of  opinion  as 
to  the  legal  position  of  this  issue.  The  matter  is  clearer 
where  a  given  form  of  accounting  has  been  prescribed  for  a 
given  class  of  concern  and  is  enforced  upon  that  concern 
through  public  examination.  Thus  the  national  banking 
act  prescribes  that  national  banks  shall  not  declare  a  divi- 
dend until  after  they  have  accumulated  a  surplus  of  at  least 
20  per  cent  of  their  capital.  In  determining  whether  sucii 
a  surplus  has  been  accumulated  or  not,  the  Comptroller  of 
the  Currency  ascertains  whether  the  assets  of  the  concern 


160  HENRY  PARKER  WILLIS 

contain  any  element  of  bad  paper  and  if  such  an  element  is 
present  it  is  usually  deducted  in  estimating  the  surplus. 
But  what  is  comparatively  simple  with  a  financial  institu- 
tion is  very  far  from  simple  when  trade  values,  fixed  capital 
of  doubtful  worth,  stocks  of  raw  materials  which  are  fluctu- 
ating in  value,  and  other  items  of  the  same  sort  are  brought 
into  question.  Here  there  may  be  a  very  fair  difference  of 
opinion  as  to  whether  a  concern  has  made  a  profit  or  not,  or 
incurred  a  loss  or  not,  and  the  question  can  be  settled  only 
tentatively  and  by  the  use  of  good  business  judgment. 

Declaration  of  Dividends. 

Upon  the  question  whether  a  profit  has  or  has  not  been 
earned  depends  ordinarily  the  action  of  the  concern  in  de- 
claring dividends.  It  may  be  good  judgment  not  to  declare 
a  dividend  even  when  a  profit  has  been  earned  but  to  keep 
it  in  the  business  for  the  purpose  of  enlarging  operations 
and  rendering  possible  a  larger  volume  of  business.  If 
there  is  a  good  deal  of  what  is  called  ''water"  in  the  cap- 
italization, it  may  be  very  desirable  to  keep  the  profit  in 
the  business  for  the  purpose  of  bringing  the  actual  worth 
of  the  assets  nearer  to  an  equality  with  the  capital  stock 
that  has  been  authorized  and  issued.  Conversely,  it  may 
be  good  policy  to  declare  a  dividend  when  a  nominal  loss 
has  been  incurred,  such  loss  being  perhaps  simply  due  to 
reinvestment  of  profits  in  assets  whose  increased  value  does 
not  appear  in  the  profit  and  loss  account.  For  example, 
if  a  concern  of  $25,000  capital  has  in  the  course  of  a  year 
invested,  say,  $5,000  in  new  machinery,  paying  therfor  out 
of  current  receipts  which  would  otherwise  have  appeared  as 
profits,  its  profit  and  loss  account  may  not  show  any  profit. 
If  the  concern  has  a  fair  balance  of  cash  the  declaration  of 
a  dividend  might  well  be  warranted  on  the  ground  that 
a  substantial  earning  had  been  made  and  that,  through  its 
reinvestment,  any  immediate  necessity  for  further  invest- 
ment of  the  same  kind  had  been  avoided.     The  declar- 


THE  PRINCIPLES  OP  ACCOUNTINa         161 

ation  of  a  dividend  is  at  all  times  largely  a  matter  of  policy. 
A  concern  whose  assets  are  recognized  as  declining  in  value 
and  likely  to  continue  to  decline,  as  in  the  case  of  the  con- 
cern which  is  working  a  terminable  patent  right  or  fran- 
chise considered  in  a  former  illustration,  may  be  perfectly 
justifiable  in  declaring  a  dividend  if  the  conditions  are 
known    to    the    stockholders    and,    if    they    realize    that 
by  accepting  a  dividend  which  represents  a  division  of  such' 
a  profit,  they  are  really  accepting  a  partial  return  of  their 
ownership  in  the  capital  of  the  concern.    The  profit  and 
loss  account  must  be  studied  in  connection  with  the  bal- 
ance sheet  and  this  will  next  be  undertaken.    It  must  how- 
ever be  borne  in  mind  that  even  when  studied  in  connec- 
tion with  the  balance  sheet  the  same  questions  as  to  de- 
preciation, appreciation,  representation  of  accrued  assets 
and  liabilities,  etc.,  that  have  already  been  spoken  of  in 
profit  and  loss  are  still  present  and  require  to  be  taken 
account  of  the  more  carefully  in  the  balance  sheet  if  they 
have  not  been  dealt  with  in  profit  and  loss  account.    If  they 
have  not  been  provided  for  in  the  accounting  at  all,  the 
same  remarks  that  apply  to  profit  and  loss  apply  in  like 
measure  to  the  balance  sheet  after  profit  and  loss  has  been 
incorporated  therein. 

XI.    THE  BALANCE  SHEET. 

Object  of  the  Balance  Sheet. 

A  brief  reference  has  already  been  made  to  the  balance 
sheet  in  speaking  of  bookkeeping  and  of  the  methods  of 
stating  the  affairs  of  a  business  (See  p.  40  foregoing).  It  is 
now  necessary  to  consider  more  particularly  what  is  meant 
by  a  balance  sheet  and  what  relation  it  bears  to  the  account- 
ing and  bookkeeping  of  the  concern.  Essentially  the  bal- 
ance sheet  is  a  statement  of  assets  and  liabilities  designed 
to  show  where  the  concern  stands  in  relation  to  the  rest 
of  the  world.    When  compared  with  former  balance  sheets, 

B— VIII— 11 


162  HENRY  PARKER  WILLIS 

it  shows  how  the  operations  of  the  concern  during  a  fiscal 
period  have  altered  its  position  as  compared  with  the  posi- 
tion it  occupied  at  the  close  of  a  preceding  fiscal  period. 
Obviously,  then,  the  things  which  must  be  aimed  at  in  a 
balance  sheet  are  not  only  an  accurate  representation  of 
assets  and  liabilities,  but  an  accurate  classification  of  such 
assets  and  liabilities  in  such  a  way  as  to  throw  them  into 
groups  comparable  with  one  another,  thus  showing  what 
the  character  of  the  assets  and  liabilities  is,  and  how  assets 
and  liabilities  of  various  descriptions  correspond  wdth  one 
another.  For  instance  it  would  not  be  enough  to  show  that 
a  concern  had  $100,000  of  assets  and  $100,000  of  liabilities. 
Neither  would  it  be  enough  to  show  that  the  concern  had 
assets  of  $100,000  and  liabilities  of  $100,000,  the  latter  be- 
ing to  the  extent  of  $50,000  capital  invested.  The  person 
who  looked  over  the  balance  sheet  would  want  to  know  of 
what  things  the  assets  consisted  and  what  was  the  nature 
of  the  liabilities.  Among  the  assets  he  would  certainly 
want  to  discriminate  between  cash,  real  estate,  plant,  and 
bills  receivable,  and  among  liabilities  he  would  want 
to  discriminate  between  capital,  bills  payable,  and  other 
classes  of  possible  demands.  He  would  want  to  know 
whether  the  bills  payable  were  short-time  or  long-time  and 
what  ones  had  either  matured  or  were  about  to  mature.  As 
the  business  becomes  more  and  more  complex  the  necessity 
for  very  careful  preparation  of  the  balance  sheet  becomes 
more  and  more  obvious. 

What  are  Assets  and  Liabilities? 

Some  writers  on  accounting  and  bookkeeping  consider 
it  sufficient  to  say  that  the  assets  of  a  business  are  found 
in  the  debtor  entries  in  its  ledger  accounts,  while  the  lia- 
bilities are  found  in  the  creditor  entries.  That  is  to  say, 
the  accounts  in  which  debit  entries  exceeded  credit  entries 
would  be  assets  to  the  extent  of  such  excess  and,  vice  versa, 
the  accounts  where  credit  entries  exceeded  debits  would  be 


THE  PEINCIPLES  OF  ACCOUNTINa         163 

liabilities  to  the  extent  of  such  excess.  This  rule  is  not 
complete  or  adequate,  for  in  preparing  a  balance  sheet  from 
the  ledger  there  will  often  be  found  a  good  many  accounts 
that  do  not  represent  assets  or  liabilities  as  such  but  sourc- 
es of  expense  or  income.  Mr.  Dicksee  suggests  the  follow- 
ing rules  for  determining  in  such  oases  whether  an  item 
is  an  asset  or  a  liability: 

(1)  When  an  item  is  on  the  left-hand  or  debtor  side  of  the  ledger — 

(a)  If  the  amount  will  eventually  be  received,  it  is  an  asset. 

(b)  If  the  amount  will  not  eventually  be  received,  it  is  a  loss. 

(2)  When  an  item  is  on  the  right-hand  or  creditor  side  of  the  ledger — ■ 

(a)  If  the  amount  will  eventually  have  to  be  paid,  it  is  a  liability. 

(b)  If  the  amount  will  not  eventually  have  to  be  paid,  it  is  a  gain. 

As  has  previously  been  seen  (see  pp.  152,  ff.  foregoing), 
what  are  classified  as  gains  and  losses  are  carried  to  profit 
and  loss,  while  assets  and  liabilities  in  the  technical  sense 
are  not  so  transferred  to  profit  and  loss,  but  represent  addi- 
tions to  the  stock  or  decreases  in  the  basic  stock  of  wealth 
owned  by  the  concern.  We  may  illustrate  this  idea  still  fur- 
ther by  considering  the  case  of  so-called  ^^ accrued"  expens- 
es. For  instance,  suppose  that  a  business  is  drawing  off 
a  balance  sheet  to  represent  the  condition  of  affairs  on 
July  1  of  a  given  year.  We  may  assume  for  the  sake  of 
argument  that  its  rent  for  the  year  is  $500  and  that  by  the 
terms  of  a  special  agreement  such  rent  is  not  payable  until 
the  end  of  the  calendar  year  or  on  December  31.  Now  this 
is  not  an  immediate  liability  and  nothing  has  been  paid  on 
it.  The  business,  however,  has  occupied  the  building  for 
six  months,  or  in  other  words  it  owes,  up  to  date,  $250  to  the 
owner  of  the  building  because  it  has  occupied  the  place 
for  that  length  of  time  and  this  amount  is  properly  and 
proportionately  chargeable.  How  would  this  be  represent- 
ed? We  might  open  an  account  headed  "Rent"  as  in  fore- 
going illustrations.  Now  if  it  were  possible  to  pay  the 
rent  for  the  half  year  and  have  done  with  it  we  should  sim- 
ply credit  cash  $250  and  debit  rent  account  **To  cash  for 
rent  of  half  year  ending  June  30. .  .$250."  "Rent"  would 
then  be  closed  into  profit  and  loss.   But,  by  the  terms  of  our 


164  HENRY  PARKER  WILLIS 

supposition,  we  do  not  pay  out  any  cash.  If,  therefore,  we 
want  to  represent  the  state  of  affairs  on  our  books  we  must 
resort  to  a  device  for  that  purpose.  Theoretically  we  might 
open  an  accoimt  with  ''Accrued  Rent"  which  we  would 
credit  with  the  amount  of  the  rent  which  had  been  incurred 
during  the  six  months  in  question.  To  complete  our  double 
entry  bookkeeping  we  might  then  open  an  account  with 
**Rent"  which  we  would  debit  with  the  occupancy  of  the 
building  as  "To  use  of  building  to  June  30.  .$250."  Then 
of  course  when  the  end  of  the  year  came  and  the  accrued 
rent  became  due  an  entry  would  be  made  to  cancel  it.  Cash 
would  be  credited  and  accrued  rent  debited  "To  Rent." 
Meanwhile  in  making  out  the  balance  sheet  we  should  have 
two  open  accounts — one  accrued  rent  with  a  credit  surplus, 
the  other  rent  with  a  debit  surplus.  Applying  the  test 
already  suggested  it  will  be  seen  that  in  the  case  of  rent 
where  the  entry  is  on  the  left  hand  or  debtor  side,  as  the 
amount  will  not  eventually  be  received  but  will  eventually 
have  to  be  paid,  it  is  a  loss.  With  accrued  rent  where 
the  entry  is  on  the  credit  side  the  amount  will  eventuallj^ 
be  paid  so  that  it  is  a  liability.  The  effect  of  this  then 
would  be  to  carry  the  debtor  entry  in  the  rent  account  to 
the  expense  side  of  profit  and  loss  while  the  credit  entry 
in  accrued  rent  account  is  a  liability.  The  balance  sheet 
when  finally  drawn  off  will  show  rent  as  a  liability  to  the  ex- 
tent of  $250  while  profit  and  loss  will  show  the  amount  due 
on  the  expense  side  as  a  loss,  thereby  cutting  do\ATi  the  net 
profit  exhibited  by  profit  and  loss  and  leaving  a  balance  in 
cash  account  of  $250  which  increases  the  assets  in  hand  to 
that  extent  and  offsets  the  liability  for  rent  which  is  exhib- 
ited among  the  liabilities  as  already  indicated.  Other  meth- 
ods of  representing  this  transaction  might  be  adopted  but 
the  principle  would  be  the  same  throughout.  The  same  idea 
might  be  applied  in  the  case  of  other  doubtful  entries  where 
it  was  uncertain  how  to  class  them — as  resources  or  liabil- 
ities.   The  point  upon  which  insistence  is  here  placed,  how- 


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THE  PRINCIPLES  OF  ACCOUNTINa         165 

ever,  is  that  every  account  in  the  ledger  may  thus  be  an- 
alyzed and  a  conclusion  arrived  at  as  to  whether  its  balance 
is  an  asset  or  a  liability,  a  profit  or  a  loss.  The  principle  of 
double  entry  which  has  been  followed  throughout  our  dis- 
cussion shows  that  if  every  debit  footing  is  taken  from  the 
ledger  and  arranged  in  a  column  for  that  purpose  and  if 
the  same  is  done  with  every  credit  footing,  the  two  sides 
will  total  the  same.  Such  an  arrangement  is  called  a  trial 
balance  and  the  same  term  is  applied  to  a  listing  of  debtor 
and  creditor  balances  as  shown  by  the  various  accounts — 
which  of  course  works  out  in  the  same  way,  that  is,  both 
columns,  debtor  and  creditor,  are  equal.  This  is  the  first 
step  toward  ascertaining  whether  the  work  is  correct  and 
toward  closing  up  the  books  as  has  already  been  seen.  (See 
p.  36  foregoing.) 

Preparing  the  Balance  Sheet. 

The  question  of  preparing  the  balance  sheet  can  now  be 
considered.  It  has  been  made  plain  that  whereas  profit, 
gain  or  income  accounts  are  closed  into  profit  and  loss,  loss, 
expense  or  outlay  accounts  are  also  closed  into  profit  and 
loss  on  the  debit  side.  Plainly,  then,  profit  and  loss  is  a  sum- 
marized and  balanced  statement  of  certain  accounts  which 
now  figure  in  the  trial  balance.  Suppose  that  profit  and 
loss  is  written  up  in  the  way  already  indicated  (see  p.  37 
foregoing)  by  transferring  the  loss  or  outlay  balances  to 
debit  side  of  profit  and  loss,  the  income  or  gain  balances  to 
the  credit  side,  and  striking  a  balance  between  them.  This 
means  that  all  of  the  accounts  thus  grouped  have  been 
sifted  out  from  the  complete  statement  of  balances  shown 
in  the  trial  balance.  The  complete  balance  sheet  will  be 
made  up  by  listing  all  the  assets  and  all  the  liabilities  grow- 
ing out  of  or  represented  in  the  accounts  which  have  not 
been  closed  into  profit  and  loss,  and  then  taking  the  bal- 
ance shown  in  profit  and  loss  and  entering  it  either  as  a  net 
profit  or  as  a  loss  as  the  case  might  be,  it  being  of  course  a 


166  HENRY  PARKER  WILLIS 

liability  to  owners  or  proprietors  the  same  as  capital  when 
it  is  a  profit,  and  an  asset  when  the  balance  shows  a  loss. 
Profit  and  loss  account  of  course  is  closed  into  capital  ac- 
count and,  this  having  been  done,  the  net  profit  appears 
in  conjunction  with  capital  as  a  liability.  The  difference 
between  assets  and  liabilities  before  capital  account  has 
been  written  up  from  profit  and  loss  is  the  net  capital — 
that  is,  the  capital  originally  shown  plus  such  addition  as 
may  have  been  made  to  it  owing  to  the  operations  of  the 
year.  If  the  difference  between  assets  and  liabilities  is 
equal  to  the  amount  shown  in  capital  account  by  writing  up 
that  account  from  profit  and  loss,  the  work  of  bookkeeping 
has  presumably  been  correctly  performed.  It  thus  ap- 
pears that  the  balance  sheet  is  a  statement  (in  complete 
form)  of  the  ledger  balances,  supposing  everything  to  be 
recorded  there,  including  both  accrued  and  realized  items 
but  omitting  the  purely  expense  and  income  items  which 
have  been  balanced  against  one  another,  the  surplus  or 
deficit  being  carried  to  capital  account  and  thus  appearing 
there  as  a  net  addition  to  or  deduction  from  capital.  Wliat 
is  meant  by  this  statement  may  be  illustrated  in  compact 
form  by  taking  a  statement  in  which  is  exhibited  in  par- 
allel columns  the  trial  balance,  inventory,  profit  and  loss, 
and  balance  sheet  as  they  stand  related  to  one  another.  In 
order  to  make  out  such  a  typical  statement  we  may  suppose 
the  existence  of  two  concerns,  A  and  B,  which  owe  the 
business  and  two  others,  C  and  D,  to  which  the  business 
is  in  debt — both  on  open  accounts.  Then  taking  the  regu- 
lar typical  accounts  such  as  bills  payable  and  receivable, 
goods,  rent,  wages,  cash,  capital,  etc.,  we  may  state  the 
items  appearing  in  the  different  columns  as  shown  here- 
with. 

To  summarize  w^hat  has  thus  been  said  of  the  balance 
sheet  in  general,  we  may  repeat  the  definition  furnished 
by  Mr.  George  Lisle  to  the  effect  that  ''The  balance  sheet 
may    ...    be  defined  as  a  statement  of  the  liabilities 


THE  PRINCIPLES  OF  ACCOUNTINa         167 

of  a  concern  (credit  balances  as  taken  from  the  ledger) 
including  the  capital,  reserve,  and  unappropriated  profit, 
on  the  one  side,  and  the  assets  of  the  concern  (debit  bal- 
ances as  taken  from  the  ledger)  including  any  deficiency, 
on  the  other.  It  thus  appears  that  the  real  difference 
between  the  profit  and  loss  account  and  the  balance  sheet 
is  that  whereas  the  former  is  intended  to  show  the  course 
of  developments  during  a  given  period,  the  balance  sheet 
shows  the  exact  position  at  a  given  moment." 

Form  of  Balance  Sheet. 

While  in  a  small  business  it  may  be  proper  and  desir- 
able to  list  practically  all  the  assets  and  all  the  liabilities 
upon  the  balance  sheet,  this  becomes  neither  practicable 
nor  desirable  as  soon  as  the  business  is  somewhat  devel- 
oped. When  it  is  seen  to  be  impossible  to  list  all  the  as- 
sets and  liabilities  separately  b}^  reason  of  the  fact  tliat 
they  are  so  numerous,  the  question  arises  how  the  assets 
and  liabilities  should  be  presented — that  is  to  say,  how 
they  should  be  grouped  for  the  purpose  of  convenient 
combination  so  as  to  show  what  the  concern  has  actually 
been  doing,  in  an  abbreviated  form.  In  the  small  busi- 
ness, the  listing  will  usually  discriminate  simply  between 
such  items  as  "open"  or  "personal"  accounts  which  will 
be  presented  as  a  lumj)  sum,  showing  what  is  due  upon 
open  account  to  the  business — cash  in  hand  and  in  bank, 
bills  receivable,  goods  on  hand,  and  real  estate — on  the 
assets  side.  On  the  liabilities  side,  it  will  distinguish  be- 
tween the  open  accounts  which  are  payable  to  others,  pre- 
senting what  the  firm  owes  to  individuals  or  corporations, 
the  amount  of  bills  payable  which  the  firm  has  outstand- 
ing, its  liability  for  the  capital  put  in  by  stockholders  and 
for  profits  also  payable  to  stockholders.  Such  groupings 
are  sufficiently  simple,  and  depend  merely  upon  a  recog- 
nition of  the  distinction  between  different  kinds  of  prop- 
erty.   A  difficulty,  however,  is  encountered  as  soon  as  the 


168  HENRY  PARKER  WILLIS 

business  becomes  more  complex  and  as  soon  as  questions 
of  accrued  assets  and  liabilities  have  to  be  taken  into  ac- 
count.    Then  the  questions  both  of  classification  and  of 
arrangement  arise.    In  the  case  of  accrued  assets,  for  ex- 
ample, such  as  interest  which  is  due  but  has  not  been  paid 
or  of  accrued  liabilities  such  as  interest  ultimately  due 
to  others  but  not  yet  payable,  the  question  of  correct  rep- 
resentation may  be  difficult.     The  balance  sheet  should 
be  made  up  from  the  ledger  and  if  that  be  done,  it  cannot 
be  more  inclusive  or  more  truthful  than  the  ledger.     It 
is   limited   to   the   accounting   set   forth   in   the   ledger. 
Unless   accrued  assets  and  liabilities  are  shown  in  the 
ledger  they  cannot  properly  appear  in  the  balance  sheet, 
except  perhaps  as  a  subsequent  notation  or  memorandum 
indicating  what  the  concern  knows  it  is  liable  for  or  has 
coming  due  to  it.    So  with  depreciation,  it  will  be  difficult 
to  represent  properly  the  status  of  the  capital  assets  un- 
less a  due  allowance  has  been  made   in   the    accounting 
scheme  for  depreciation,  so  that  the  results  as  there  duly 
set  forth  can  be  taken  up  on  the  balance  sheet.    Suppos- 
ing that  due  allowance  has  been  made,  however,  for  these 
various  elements  affecting  the  position  of  the  concern  in 
the  accounting,  the  balance  sheet  will  be  merely  a  repre- 
sentation of  them.    It  is  worth  noting  at  this  point  that, 
according  to  the  accounting  treatment  which  is  adopted 
in  the  ledger,  given  items  may  appear  either  on  one  side 
or  on  the  other.    Depreciation,  for  example,  may  be  found 
in  the  balance  sheet  as  an  asset.    This  will  be  the  case  in 
the  event  that  a  given  sum  of  money  has  simply  been  set 
aside  or  invested  for  the  purpose  of  offsetting  deprecia- 
tion in  plant,  real  estate,  fixtures,  etc.,  or  it  may  appear 
both  on  the  assets  and  liabilities  sides  as  will  be  the  case 
in  the  event  that  the  fund  set  aside  is  invested  as  a  safe- 
guard without  correspondingly  reducing  the  book  value 
of  the  assets,  so  that  it  is  considered  necessary  to  repre- 
sent a  liability  therefor  on  the  liabilities  side  in  the  form 


THE  PRINCIPLES  OF  ACCOUNTING         169 

of  surplus,  this  being  practically  analogous  to  an  addition 
to  capital.  Or  depreciation  may  simply  appear  as  a  lia- 
bility, as  will  be  the  case  if  a  given  sum  is  written  off  from 
the  net  profit  and  set  aside  for  the  purpose  of  offsetting 
the  wasting  of  assets  without  dissociating  this  fund  from 
other  assets,  it  being  left  simply  as  an  element  of  wealth 
in  the  hands  of  the  business  itself.  The  same  thing  is  like- 
wise true  of  other  funds  of  the  same  kind,  such  as  funds 
set  aside  for  insurance  and  the  like.  It  may  be  said  then 
that  the  precise  form  of  the  balance  sheet — that  is  to  say, 
the  actual  elements  counted  as  assets  or  liabilities,  the 
inelusiveness  of  the  sheet,  its  accuracy,  etc.,  depends  al- 
most entirely  upon  the  system  of  accounting  that  has  been 
pursued.* 

Grouping  the  Items. 

But  when  the  actual  items  of  assets  and  liabilities  have 
been  designated  in  the  way  referred  to,  there  still  remains 
the  question  of  grouping  them.  This  grouping  may  fol- 
low any  one  of  a  number  of  different  methods.  The  one 
generally  preferred  is  the  so-called  *' standard  form  of  bal- 
ance sheet"  which  Mr.  Dickinsonf  has  described  as  fol- 
lows: "The  standard  form  of  balance  sheet  .  .  .  divides 
the  assets  into  three  classes,  namely:  Capital,  represent- 
ing the  fixed  investment  in  the  property;  current,  repre- 
senting the  assets  which  are  being  turned  over  and  con- 
verted into  a  different  form  day  by  day;  and  deferred, 
representing  expenses  incurred  in  advance  for  some  suc- 
ceeding period;  and  to  these  three  is  frequently  added  a 
fourth  representing  the  assets  held  for  special  funds,  which 
may  have  been  set  aside  out  of  profits  or  otherwise  for 
specific  purposes.  On  the  liabilities  side  a  similar  classi- 
fication prevails,  viz:  Capital  liabilities,  representing  the 
capital  stock  and  funded  debt  which  have  been  contrib- 

*  See  citation  from  Mr.    Cole,  given  on  p.  94  foregoing, 
t  Accounting  Practice  and  Procedure,  p.  16. 


170 


HENRY  PARKER  WILLIS 


uted  and  remain  fixed,  at  any  rate  for  a  niunber  of  years; 
current  liabilities,  including  floating  debt,  wliicli  have  to 
be  paid  off  in  the  ordinary  course  of  business  from  day 
to  day;  special  funds  set  aside  for  various  purposes,  such 
as  depreciation,  sinking  fund,  etc.;  and,  finally,  surplus 
or  profit  and  loss  account,  representing  the  accumulation 
of  undistributed  profits.  This  form  is  that  most  common- 
ly adopted  here,  each  of  the  principal  headings  being  again 
divided  into  such  sub-accounts  as  may  be  desired."  This 
may  be  illustrated  by  representing  in  outline  a  standard 
form  of  railroad  balance  sheet  in  the  shape  presented  by 
Mr.  Cole*  as  follows: 

FORM  OF  RAILROAD  BALANCE  SHEET. 


Capital  Assets — 

Cost  of  road. 

Stocks   and   bonds, 

Sinking  fund, 
Available  Assets — 

Accounts  receivable, 

Due  from  other  roads, 

Supplies, 

Cash, 
Accrued  Assets — 

Interest, 


Contingent  Assets — 
Suspense  Account, 


Capital  Liabilities — 
Capital   stock, 
Funded  debt, 
Sinking   fund,  _ 

Current  Liabilities — 
Bilk   payable, 
Accounts   payable, 
Due  other  roads. 
Claims  audited. 

Accrued   Liabilities — 
Rentals, 
Interest, 

Profit  and  Loss, 


Contingent  Liabilities — 
Guaranteed  bonds   of  sub- 
sidiary roads,  | 


This  division  of  the  balance  sheet  is  not  that  which  is 
adopted  in  England,  where  accounting  practice  is  care- 
fully regulated  by  law  and  where  the  standard  form  of 
balance  sheet  is  entirely  different  in  certain  respects  from 
that  which  has  been  indicated  above.  In  the  English  form 
each  class  of  asset  is  set  forth  by  itself  in  the  balance  sheet 
in  an  order  which  is  supposed  to  follow  the  ease  of  liquida- 
tion. Thus  the  fixed  assets  are  stated  first,  then  those 
which  are  more  easily  realizable  follow  in  their  order^  while 


*  Accounts,  p.  177, 


THE  PRINCIPLES  OF  ACCOUNTING         171 

cash  comes  last.  So,  on  the  liabilities  side,  the  liabilities 
that  are  most  remote  in  their  character,  such  as  capital, 
are  stated  first  and  are  then  followed  by  the  others  in  the 
order  of  immediateness,  those  last  mentioned  being  the 
ones  that  are  payable  at  once.  There  is  no  special  object 
to  be  gained  in  discussing  the  relative  values  of  these  va- 
rious kinds  of  balance  sheet.  The  important  thing  is  to 
have  the  balance  sheet  arranged  upon  a  definite  principle 
with  the  various  groups  in  accordance  therewith.  For 
ease  of  convenience  in  quickly  understanding  the  position 
of  the  concern  from  the  standpoint  of  immediate  solvency, 
the  English  form  is  probably  the  more  desirable  of  the 
two  forms  just  indicated,  while  from  the  standpoint  of 
ultimate  analysis  the  American  form  may  in  some  respects 
be  preferable.  It  is  worth  while  to  note  in  this  connec- 
tion the  form  of  statement  which  is  prescribed  for  national 
banks  reporting  to  the  United  States  Government.  This 
is  the  outcome  of  very  careful  legislation  and  of  years  of 
experience  with  a  particular  class  of  institutions  whose 
business  has  been  carefully  studied  and  is  susceptible  of 
very  close  analysis.  The  form  of  Assets  and  Liabilities 
Statement  adopted  by  the  Government  and  made  compul- 
sory upon  the  national  banks,  is  shown  on  page  172. 

Examination  of  this  statement  of  resources  and  liabili- 
ties shows  that  in  a  rough  general  way  the  order  of  liquid- 
ity is  followed  in  the  statement.  For  example,  under  the 
head  of  liabilities  the  capital  items — capital,  surplus  and 
undivided  profits — are  first  mentioned.  Then  are  enu- 
merated the  demand  liabilities  mentioning  first  the  bank 
notes  outstanding,  then  the  sums  due  to  national  and  state 
banks,  trust  companies,  etc.,  the  sums  payable  on  sight 
as  dividends  already  declared,  and  then  the  deposits  of 
various  kinds.  Up  to  this  point,  the  order  of  arrangement 
has  distinctly  been  that  of  the  relative  immediateness  of 
the  liability  involved  by  the  different  items.  At  the  end 
of  the  classification  are  given  several  captions  which  have 


172 


HENRY  PARKER  WILLIS 


NATIONAL  BANK  STATEMENT. 


Resources. 

Loans  and  discounts 

Overdrafts    

U.  S.  Bonds  to  secure  cir- 
culation      

U.  S.  Bonds  to  secure  U. 
S.    deposits    

Other  bonds  to  secure  U. 
S.  deposits  

U.  S.  Bonds  on  hand 

Premiums  on  U.  S.  Bonds 

Bonds,  securities,  etc 

Banking  house,  furniture, 
and  fixtures  

Other  real  estate  owned.. 

Due  from  national  banks 
(not  reserve  agents)  . . . 

Due  from  state  banks  and 
bankers,  trust  com- 
panies,  etc 

Due  from  approved  re- 
serve agents    

Checks  and  other  cash 
items    _. . . 

Exchanges  for  clearing 
house •  •  •  • 

Bills  of  other  national 
banks    

Fractional  currency,  nick- 
els, and  cents  

Specie    

Legal-tender  notes   

Five  per  cent  redemption 
fund    

Due  from  Treasurer  U.  S. 
other  than  5  per  cent 
fund    

Total   


Liabilities. 

Capital  stock  paid  in 

Surplus  fund   

Undivided  profits,  less  ex- 
penses and  taxes  

National-bank   notes    out- 
standing     

State-bank       notes       out- 
standing     

Due  ,  to     national     banks 
(not  reserve  agents)  . . . 

Due    to    state   banks    and 
bankers    

Due    to    trust    companies 
and   savings   banks 

Due   to   approved   reserve 
agents    

Dividends  unpaid 

Individual  deposits 

U.   S.   deposits    

Deposits  of  U.  S.  disburs- 
ing officers    

Bonds  borrowed    

Notes     and     bills     redis- 
counted   

Bills  payable  

Reserved  for  taxes   .... 

Liabilities  other  than 
those  above  stated... 


Total 


been  placed  last  notwithstanding  that  they  do  not  repre- 
sent immediately  maturing  liabilities.  On  the  resources 
or  assets  side,  is  found  the  same  general  order  of  group- 
ing, the  classification  followed  being  in  the  main  that  of 
immediateness  of  realization  or  availability,  although  there 
are  one  or  two  violations  in  this  order  of  statement  as  is 
seen  in  the  entering  of  banking  house  and  real  estate  lower 
down  in  the  assets  column  than  the  securities  o^Tied.  This, 
however,  is  for  a  special  reason  connected  with  the  arrange- 


THE  PRINCIPLES  OF  ACCOUNTING         173 

ment  of  the  national  bank  report  which  need  not  be  con- 
sidered here. 

Interpretation  of  Balance  Sheet. 

From  what  has  been  said  it  will  be  inferred  that  tfie 
balance  sheet  is  the  essential  guide  of  the  individual  who 
wishes  to  form  a  general  idea  of  the  condition  of  the  busi- 
ness at  any  moment.  We  have  indicated  some  of  the  main 
considerations  governing  the  correct  statement  of  the  con- 
dition of  a  business  upon  the  balance  sheet.  It  should 
be  remembered,  however,  that,  as  already  stated,  the  bal- 
ance sheet  is  intended  to  represent  the  condition  existing 
at  any  particular  moment,  while  the  profit  and  loss  ac- 
count shows  the  process  by  which  the  existing  condition 
has  been  arrived  at.  It  is  frequently  more  important  for 
the  prospective  buyer  of  a  business  or  of  a  part  of  it  to 
know  what  the  general  direction  of  the  business  has  been 
over  a  period  of  past  time  than  to  know  exactly  what  con- 
dition it  is  in  at  the  moment.  Of  course  he  wants  to  know 
the  latter,  but  no  matter  how  sound  the  assets  may  be 
the  buyer  will  not  want  to  take  them  over  unless  he  thinks 
there  is  a  probability  that  they  will  increase  in  value  or 
that  he  will  have  an  opportunity  of  making  profits.  He 
cannot  correctly  interpret  the  balance  sheet,  therefore,  if 
he  has  only  one.  He  must  have  that  for  the  last  preceding 
fiscal  period  and  perhaps  others  for  earlier  periods.  With 
these  he  is  in  a  position  to  make  a  comparison  of  the  tend- 
encies of  the  business  over  a  series  of  past  years  and  to 
form  his  own  idea  of  the  reasons  which  have  put  the  con- 
cern into  its  existing  position.  The  basis  of  such  an  in- 
terpretation, however,  will  have  to  be  an  exact  compara- 
bility between  the  classifications  of  the  balance  sheet. 
Uniformity  in  the  methods  of  making  up  the  sheet  must 
therefore  be  maintained,  and  there  can  be  no  question  as 
to  the  items  which  go  to  make  up  a  given  grouping  of  as- 
sets or  liabilities  if  an  accurate  comparison  is  to  be  insti- 


174  HENRY  PARKER  WILLIS 

tuted.  In  cases  where  a  necessary  regrouping  of  items 
has  occurred,  this  can  be  tolerated  only  upon  condition 
that  there  is  a  most  careful  explanation  of  the  reason  for 
it  and  the  effect  it  has  had  in  changing  the  showing  made 
in  the  sheet.  Otherwise  comparisons  designed  to  show  the 
growth  of  business  are  without  foundation.  Supposing, 
however,  that  uniformity  has  thus  been  observed,  the  ques- 
tion of  judging  of  the  balance  sheet  and  what  it  shows 
still  remains,  and  is  to  the  investor  and  business  man  a 
most  important  matter.  It  should  be  stated,  however,  that 
the  considerations  which  must  govern,  in  judging  the  bal- 
ance sheet  and  its  meaning,  are  largely  those  of  business 
experience  and  are  not  primarily  those  of  accounting.  The 
judging  of  the  balance  sheet,  however,  must  be  conducted 
upon  fundamental  principles  of  accounting  which  apply  to 
all  balance  sheets. 

This  process  of  interpretation  is  essentially  that  of  esti- 
mating whether  the  business  has  passed  through  a  process 
of  normal  growth  and  development  or  whether  its  history 
presents  features  of  abnormal  expansion  or  of  abnormal 
under-development.  While,  as  above  remarked,  every  par- 
ticular class  of  business  has  its  own  criteria  for  judging 
of  these  matters,  certain  basic  propositions  of  accounting 
apply.  First  of  all,  the  student  of  the  balance  sheet  wants 
to  know  whether  the  concern  is  making  a  normal  profit. 
His  balance  sheet,  if  correctly  made  up,  shows  him  the 
total  capital  engaged  in  the  business,  whether  this  be  in 
the  form  of  an  actual  investment  originally  made  with 
the  use  of  the  capital  funds  contributed  at  the  start  or 
whether  it  be  in  the  form  of  subsequent  additions  to  capi- 
tal put  in  out  of  profits.  It  shows,  of  course,  whether  the 
business  has  more  capital  stock  outstanding  than  what 
corresponds  to  the  actual  worth  of  its  capital  assets,  or 
whether  it  is  under-capitalized  by  reason  of  the  fact  that 
capital  assets  exceed  in  value  the  nominal  amount  of  cap- 
ital stock  outstanding.    All  of  this  depends  upon  whether 


THE  PRINCIPLES  OP  ACCOUNTINa         175 

correct  valuations  have  or  have  not  been  made,  but,  as- 
suming these  to  have  been  made  in  the  first  place,  the 
materials  for  judgment  are  afforded  as  indicated.  The 
balance  sheet  will  also  show  whether  the  concern  has  been 
working  too  largely  upon  a  credit  basis.  It  will  show  this 
through  the  bills  receivable  and  payable  accounts  as  com- 
pared with  cash  in  bank.  A  knowledge  of  practice  in  the 
particular  branch  of  business  which  is  under  consideration 
affords  the  basis  for  judging  whether  the  line  of  credit 
extended  and  obtained  is  too  great  and  whether  therefore 
bad  judgment  has  been  shown  in  not  getting  to  a  more 
nearly  cash  payment  basis.  From  a  complete  balance 
sheet,  an  idea  of  the  rate  of  turn-over  of  capital  can  be 
obtained,  and  this  will  give  some  light  upon  the  question 
whether  the  volume  of  business  is  such  as  to  warrant  the 
making  of  better  profits  in  the  future  under  a  more  skilled 
management,  or  whether  the  existing  management  has 
done  as  well  as  could  have  been  expected  with  the  given 
turn-over  of  capital.  The  same  considerations  will  also 
throw  light  upon  the  question  whether  too  large  a  volume 
of  fixed  assets  is  or  is  not  employed,  considering  the  na- 
ture of  the  business.  All  of  these  elements  in  the  problem 
of  judging  the  balance  sheet  are  dependent  upon  knowl- 
edge of  the  business,  as  well  as  correct  statement  of  the 
accounting  situation,  but  the  latter  is  essential  to  the  ex- 
ercise of  the  business  knowledge  referred  to. 

Capital  and  Revenue  Items. 

In  making  a  judgment  of  the  kind  already  referred 
to  in  the  case  of  any  business  which  employs  a  large  fixed 
capital,  decided  difficulty  is,  however,  encountered  by 
reason  of  the  fact  that  it  is  not  easy  for  the  reader  of  the 
balance  sheet  to  form  an  idea  exactly  how  far  the  expendi- 
tures of  the  concern  (and  its  incomes  as  well)  are  due  to 
capital  and  how  far  to  revenue.  At  an  earlier  point  (see 
p.  95  foregoing)'  reference  has  been  made  to  some  diffi.- 


176  HENRY  PARKER  WILLIS 

culties  in  deciding  initially  whether  a  given  expenditure 
has  been  made  for  the  purpose  of  increasing  capital  or 
whether  it  has  been  made  for  the  mere  purpose  of  main- 
taining it  or  repairing  the  results  of  accident  or  immediate 
wear  and  tear.  It  is  much  harder  in  the  case  of  the  bal- 
ance sheet  to  form  an  opinion  on  this  subject  and,  there- 
fore, in  some  cases  it  is  deemed  best  to  adopt  what  is  called 
the  "double  account  system,"  the  object  of  which  is  that 
of  segregating  items  of  income  and  expenditure  relating 
to  capital  and  items  of  income  and  expenditure  relating 
distinctly  to  income  or  profit.  The  principle  of  the  double 
account  form  of  balance  sheet  may  be  briefly  described. 
The  object  in  view  is  to  show  how  much  capital  has  been 
originally  obtained  from  the  stockholders  or  partners,  how 
much  has  been  put  into  fixed  forms  or  capital  assets,  how 
much  has  been  retained  as  floating  capital  for  the  pur- 
pose of  running  the  plant  and  thereby  making  a  profit. 
In  other  words  it  is  endeavored  to  discriminate  between 
the  amount  actually  tied  up  in  a  plant  and  the  amount 
kept  in  a  fluid  form  for  the  purpose  of  carrying  on  busi- 
ness in  the  narrow  sense  of  the  term.  In  conducting  the 
concern  the  effort  is  made  in  every  case  to  discriminate 
carefully  betw^een  classes  of  receipts  recognizing  all  funds 
received  from  stockholders,  bondholders,  etc.,  as  capital  re- 
ceipts, and  crediting  them  to  capital  account,  while  other 
receipts  are  those  that  come  in  the  course  of  the  operation 
of  the  business  and  are  the  fund  from  which  net  profits 
are  to  be  withdrawn  after  deduction  of  running  expenses 
has  been  made.  So  also  it  is  sought  to  discriminate  care- 
fully between  expenditures  on  capital  account  and  expendi- 
tures on  running  account.  The  outlays  on  capital  account 
are  those  which  are  made  by  expending  the  cash  capital 
for  actual  fixed  forms  of  assets,  such  as  machinery,  plant, 
etc.  Outlays  on  running  expenses,  salaries,  repairs,  etc., 
are  revenue  expenditures  and  as  such  go  to  profit  and  loss 
account  (see  p.  163  foregoing  for  statement  of  principles 


THE  PRINCIPLES  OP  ACCOUNTING-         177 

upon  which  to  discriminate  between  assets  and  liabilities, 
losses  and  gains).  It  is  clear  from  what  has  been  said 
that  in  managing  the  accounts  in  the  way  just  indicated 
it  is  desirable  to  refrain  from  ''writing  down"  or  "writing 
off"  the  assets  for  the  period  and  to  state  everything  at 
the  original  cost  value.  In  order  to  provide  for  deprecia- 
tion, profit  and  loss  will  be  debited  with  the  amount  that 
it  has  been  determined  to  set  aside  and  depreciation  fund 
account  will  be  credited.  In  this  case  depreciation  fund 
wall  appear  as  a  liability  on  the  general  balance  sheet  be- 
cause it  will  eventually  have  to  be  paid  out  for  the  pur- 
pose of  improving  the  capital  assets  so  as  to  restore  them 
to  their  original  position  or  else  they  will  be  augmented 
by  the  addition  of  other  assets  whose  cost  value  is  sup- 
posed to  equal  the  loss  on  depreciation.  Suppose  a  con- 
cern which  intends  to  present  its  affairs  on  the  double  ac- 
count system  allows  a  certain  depreciation  for  the  opera- 
tions of  the  first  year,  it  can  then  in  starting  its  account- 
ing for  the  second  year  write  off  the  assets  to  the  extent 
of  the  amount  allowed  for  depreciation,  either  holding  spe- 
cial investments  obtained  by  the  use  of  the  depreciation 
allowance  or  else  it  can  increase  the  amount  of  the  capi- 
tal assets  by  expending  thereon  the  sum  set  aside  for  de- 
preciation, making  the  corresponding  reduction  or  writ- 
ing off  the  book  value  of  the  assets.  This  double  account 
system  is  essentially  merely  a  different  way  of  present- 
ing the  operations  of  the  concern  in  the  balance  sheet  and 
may  be  illustrated  by  a  sample  form  showing  the  difference 
between  double  and  single  statement  based  upon  one  fur- 
nished by  Mr.  Dicksee  when  discussing  the  subject  as  af- 
fected by  the  English  companies'  act.*  The  statement  is 
exhibited  in  modified  form  on  the  following  page. 

*  Bookkeeping  for  Accountant  Students,  pp.  246-9. 


B— VIII— 12 


178 


HENRY  PARKER  WILLIS 


Single  Account  System. 
THE  A.  B.  COMPANY. 

Balance  Sheet  June  30,  1910, 


Assets. 

Plant,  machinery,  leases,  etc 
as-  per  last  statement.... 
Extensions   to   date 

Less  depreciation    

Stock  on  hand 

Investments     

Accounts  receivable   

Cash  in  bank  and  in  hand. . . 


Liabilities. 

Par  value  of  capitalj_ 

Capital  paid  up. 
Preferred  stock, 
Common  stock,     _ 

Bonds, 
Reserve  Fund, 
Current  Liabilities, 
Bills  payable, 
Accounts  payable, 


Profit  and  loss  account, 


Double  Account  System. 
THE  A.  B.  COMPANY. 

Capital  Account  for  Year  Ended  June  30,  1910. 


Dr. 

Cr. 

Expend- 
iture to 
June  30, 
1909. 

Expended 
June  30, 

1909-June 
30,  1910. 

—  "o 

Receipts 

to 
June  30, 

1909. 

Received 

June  30, 

1909-June 

30,  1910. 

Total 
Receipts 
to  June 
30,  1910. 

To  Leases, 
"    Real   Estate, 
"    Machinery, 

By  Preferred    Stock, 
"    Common  Stock, 
"    Bonds, 

"    Balance    of    Cap- 
ital Account, 

General  Balance  Sheet,  June  30,  1910. 


Assets. 

Stock  on  Hand, 
Investments, 
Accounts    Rec'ble, 
Cash  in  bank  and  in 
hand. 

Liabilities. 

Capital  Account  bal- 
ance, 

Reserve  Fund, 

Depreciation    Fund, 

Current  Liabilities, 
Bills  payable, 
Accounts   payable, 

Profit  and  Loss  Ac- 
count, 

CIPLES  OF  ACCOUNTING         179 


There  is  also  submitted  a  sample  of  the  regular  rail- 
way balance  sheet  required  of  American  railroads  by  the 
Interstate  Commerce  Commission  and  following  in  some 
respects  the  same  line  as  that  which  has  been  made  com- 
pulsory for  use  by  certain  classes  of  concerns  under  the 
English  companies'  act  as  above  stated  (see  p.  176).  It 
is  clear  that  where  but  little  fixed  capital  is  employed, 
the  adoption  of  the  double  account  system  is  not  at  all 
necessary  or  perhaps  desirable.  The  English  companies' 
acts  make  it  compulsoiy  for  certain  classes  of  railroad 
and  street  railway  companies  and  for  certain  classes  of 
gas  companies.  In  general,  however,  it  is  a  suitable  way 
of  presenting  the  facts  in  the  case  of  all  concerns  which 
have  the  larger  part  of  their  capital  invested  in  permanent 
or  fixed  assets.  This  would  include  public  service  corpora- 
tions of  many  kinds,  including  railways,  gas,  water,  elec- 
tric light,  telegraph  and  telephone  companies,  and  in  addi- 
tion it  would  include  analogous  concerns  of  a  private  char- 
acter such  as  mining  businesses  and  others  having  a  very 
large  fixed  capital  investment  subject  to  depreciation.  The 
element  of  depreciation  becomes  less  and  less  important 
and  the  change  in  the  value  of  capital  assets  less  and  less 
significant  as  a  larger  and  larger  proportion  of  the  cap- 
ital is  used  in  floating  form.  For  example,  in  the  case 
of  the  bank  or  financial  institution  there  is  no  field  for  the 
use  of  such  a  system  of  accounting  as  has  just  been  re- 
feired  to,  because  there,  there  is  no  substantial  investment 
in  material  assets,  the  capital  being  employed  in  the  pur- 
chase and  realization  of  commercial  paper,  securities,  etc. 

Form  of  General  Balance  Sheet  Statement. 

ASSETS. 
Property  owned  as  investment : 

I.     Physical  Property  Owned — 

1-A.    Road  and  Equipment  to  June  30,  1907 — 
(o)     Road. 
(&)     Equipment. 
1-B.    Road  and  Equipment  since  June  30,  1907 — 

(a)  Road. 

(b)  Equipment. 

(c)  General  Expenditures. 


180  HENRY  PARKER  WILLIS 

II.  Securities  Owned — 

Z.    Securities  of  Proprietary,  Affiliated,  and  Controlled  Companies — 
Pledged— 

(a)  Stocks. 

(b)  Funded  Debt. 

(c)  Miscellaneous. 

3.     Securities  Issued  or  Assumed — Pledged — 

(a)  Stocks. 

(b)  Funded  Debt. 

(c)  Miscellaneous. 

4.  Securities  of  Proprietary,  Affiliated,  and  Controlled  Companies — 

Unpledged — 

(a)  Stocks. 

(b)  Funded  Debt. 

(c)  Miscellaneous. 

III.  Investments — 

5.  Advances  to  Proprietary,  Affiliated,  and  Controlled  Companies  for 

Construction,  Equipment,  and  Betterments. 

6.  Other  Permanent  Investments — 

(a)  Physical  Property. 

(b)  Securities. 
Working  Assets : 

7.  Cash.  , 

8.  Marketable  Securities — 

A.  Securities  Issued  or  Assumed — Unpledged — • 
(a)     'Stocks. 

(6)     Funded  Debt. 
(c)     Miscellaneous. 

B.  Other  Marketable  Securities — 

(a)  Stocks. 

(b)  Funded  Debt. 

(c)  Miscellaneous. 

9.  Loans  and  Bills  Receivable. 

10.  Net  Traffic,  Car  Mileage,  and  Per  Diem  Balance. 

11.  Net  Balance  Due  from  Agents  and  Conductors. 

12.  Miscellaneous  Accounts  Receivable. 

13.  Materials  and  Supphes. 

14.  Other  Working  Assets. 
Deferred  Debit  Items : 

15.  Advances — 

(a)  Advances  to  Proprietary,  Affiliated,  and  Controlled  Companies. 

(b)  Working  Funds. 

(c)  Other  Advances. 

16.  Insurance  Premiums  Paid  in  Advance. 

17.  Taxes  Paid  in  Advance. 

18.  Discount  on  Securities  Issued — 

(a)  Discount  on  Stock. 

(b)  Discount  on  Funded  Debt. 

19.  Property  Abandoned,  Chargeable  to  Operating  Expenses. 

20.  Cash  and  Securities  in  Sinking  and  Redemption  Funds. 

21.  Cash  and  Securities  in  Insurance  and  Other  Special  Funds. 

22.  Cash  and  Securities  in  Special  Trust  Funds. 

23.  Items  in  Suspense. 


Deficit : 


Stock : 


24.  Profit  and  Loss — ^Balance. 

LIABILITIES. 

25.  Capital  Stock — 

(a)     Common  Stock. 
(6)     Preferred   Stock. 
(c)     Debenture  Stock. 

26.  Receipts  Outstanding  for  Capital  Stock. 


THE  PRINCIPLES  OF  ACCOUNTING         181 

27.  Stock  Liability  for  Conversion  of  Outstanding  Securities  of  Constitu- 

ent Companies. 

28.  Premium  Realized  on  Capital  Stock  Sold. 
Mortgage.  Bonded,  and  Secured  Debt: 

29.  Funded  Debt- 
Co)     Mortgage  Bonds. 

(&)  Collateral  Trust  Bonds. 

(c)  Plain  Bonds,  Debentures,  and  Notes. 

(d)  Income  Bonds. 

(e)  Equipment  Trust  Obligations. 

(/)     Miscellaneous  Funded   Obligations. 

30.  Receipts  Outstanding  for  Funded  Debt. 

31.  Premium   Realized   on  Funded   Debt   Sold. 

32.  Receivers'  Certificates. 

33.  Obligations  for  Advances  Received  for  Construction,  Equipment,  and 

Betterments. 
Working  Liabilities : 

34.  Loans  and  Bills  Payable. 

35.  Net  Traffic,  Car  Mileage,  and  Per  Diem  Balance. 

36.  Audited  Vouchers  and  Wages  Unpaid. 

37.  Miscellaneous  Accounts  Payable. 

38.  Matured  Dividends,  Interest,  and  Rents  Unpaid. 

39.  Matured  Mortgage,  Bonded,  and   Secured  Debt  Unpaid. 

40.  Working  Advances  Due  to  Other  Companies. 

41.  Other  Working  Liabilities. 
Accrued  Liabilities  Not  Due  : 

42.  Dividends  Declared  and  Interest  and  Rents  Accrued,  Not  Due. 

43.  Taxes  Accrued, 
Deferred  Credit  Items : 

44.  Operating  Reserves — 

(a)  Reserves  for  Replacement  of  Property. 

(b)  Reserves  for  Other  Purposes. 

45.  Liability  on  Account  of  Special  Trust  Funds. 

46.  Items  in  Suspense. 
Appropriated  Surplus : 

47.  Surplus  Reserves — 

(a)  Reserves  Invested  in  Sinking  and  Redemption  Funds. 

(b)  Reserves  Invested  in  Insurance  and  Other  Special  Funds. 

(c)  Reserves  Not  Specifically  Invested. 

48.  Additions  to  Property  through  Income  since  June  30,  1907. 
Free  Surplus : 

49.  Profit  and  Loss — Balance. 

Statement  of  Aifairs. 

The  term  '^balance  sheet"  is  usually  applied  to  a  state- 
ment of  the  kind  already  described  relating  to  the  affairs  of 
a  solvent  company.  Supposing,  however,  that  a  concern 
is  insolvent  or  bankrupt,  the  question  of  representing  its 
position  to  the  creditors  and  others  arises,  and  then  the 
problem  must  be  faced  whether  all  that  is  needed  is  a 
plain  balance  sheet  or  not.  In  such  a  case,  it  is  probable 
that  more  details  are  wanted  than  those  that  are  afforded 
by  the  balance  sheet.    It  is  customary,  for  such  conditions, 


162  HENRY  PARKER  WILLIS 

to  draw  up  what  is  called  a  *'  statement  of  affairs."  This 
statement  of  affairs  lists  the  liabilities  in  substantially  the 
same  way  as  would  be  done  on  a  balance  sheet  except  that 
now  the  effort  is  to  indicate  also  the  relative  values  of  the 
liabilities  and  the  relative  degrees  of  their  urgency.  It 
may  be  shown,  for  example,  whether  they  are  actual  lia- 
bilities or  only  contingent,  whether  they  are  specially  se- 
cured or  simply  *' general  creditors."  So  also  with  the 
assets  the  listing  will  endeavor  to  show  whether  they  are 
to  be  classed  as  unquestionably  realizable  or  doubtful  and 
to  indicate  whether  they  are  subject  to  special  claims  which 
will  reduce  their  worth  or  not.  The  fixed  assets  will  be 
shown  valued  upon  a  basis  supposed  to  indicate  what  can 
actually  be  realized  for  the  purpose  of  meeting  liabilities. 
It  is  clear  that  in  such  a  statement  two  classes  of  knowl- 
edge are  called  for  which  may  or  may  not  be  furnished 
by  the  accounting  system  but  which  probably  will  not  be. 
These  are  (1)  the  character  of  the  liabilities  from  the  legal 
standpoint — whether  preferred  or  not,  and  (2)  the  prob- 
able actual  value  of  the  assets  at  immediate  sale  or  dispo- 
sition. In  this  case  the  values  assigned  to  the  assets  are 
likely  to  vary  more  or  less  from  those  which  are  repre- 
sented on  the  books.  Moreover,  the  arrangement  of  the 
statement  of  affairs  is  different  from  that  likely  to  be 
adopted  in  the  balance  sheet  since  it  will  now  be  sought 
to  show  the  amounts  of  the  assets  and  liabilities  respec- 
tively in  their  relative  rank.  A  sample  of  such  a  state- 
ment of  affairs  patterned  after  that  furnished  as  an  illus- 
tration by  Mr.  George  Lisle*  is  herewith  submitted.  (p.l83.) 
The  statement  of  affairs  is  thus  seen  to  be  a  variety 
of  balance  sheet,  differing  from  the  ordinary  type  of  sheet 
simply  in  details,  the  changes  being  made  because  of  its 
special  uses  in  showing  the  realizable  value  of  assets  against 
specified  liabilities.  In  English  accounting  it  is  customary 
to  supplement  such  a  statement  of  affairs  by  drawing  up 

*  Accounting  in  Theory  and  Practice. 


THE  PRINCIPLES  OF  ACCOUNTING 


183 


Assets. 


JOHN  SMITH  &  CO. 

Statement  of  Affairs,  Dec.  31,  1910. 


Liabilities. 


is2 


Cash    

On'  hand   

In  bank  . ... ..... 

Goods — 
Customers   Accts., 

Good     

Doubtful    

Bad   _ 

Machinery,  Fixtures, 

etc 

Real  Estate, 

Valued  at, 

Less   Mortgage, 


Investments  assign- 
ed to  creditors  and 
deducted  from  lia- 
bilities, 


Deduct. 
Preferred    Creditors' 

Claims, 
Assets  Available  for 

Division, 
Among  unsecured 

Creditors   

Deficiency  of  assets. 


Unsecured  Creditors 
Open  accounts  . . . 
Loans   

Creditors     fully    se- 
cured     by     mort- 
gage,  deducted 
from  assets. 


Creditors  Partially 
secured, 

Deduct  Investments 
Assigned  to  Credi- 
tors     


Contingent  Liability 
for  paper  discount- 
ed, etc.. 


Preferred  Claims, 
Taxes, 
Wages, 
Rent, 


Deducted  from 
Assets, 


what  is  called  a  "deficiency  account."  The  deficienc}"  ac- 
count is  intended  to  show  the  summarized  results  which 
are  generally  indicated  in  the  statement  of  affairs.  The 
credit  entries  are  those  which  usually  appear  in  capital 


184 


HENRY  PARKER  WILLIS 


account — the  original  capital  and  the  subsequent  profits 
realized  in  succeeding  fiscal  periods.  In  addition  to  these, 
is  credited  the  deficiency  or  shortage  which  the  statement 
of  affairs  shows  to  exist.  The  debit  entries  show  the  va- 
rious elements  of  loss,  such  as  shrinkage  in  the  value  of 
assets,  the  cash  drawn  out  (in  the  case  of  a  partnership 
or  an  individual  business),  etc.  In  other  words  the  de- 
ficiency account  shows  the  original  capital  put  in  and  the 
amount  subsequently  added  through  clear  profit,  while  it 
also  shows  where  this  capital  has  gone,  that  is,  how  it  has 
been  disposed  of.  The  two  sides  are  balanced  by  an  entry 
giving  the  deficiency  or  shortage  as  already  indicated.  A 
sample  of  such  an  account  based  upon  and  dra^Ti  from 
the  statement  of  affairs  already  supplied  is  herewith  fur- 
nished. 

JOHN  SMITH  &  CO. 
Dr.  Deficiency  Account.  Cr. 


To  loss  from  shrinkage  in 
value      of      Assets      as 
shown  by  statement  of 
aflfairs: 

Goods, 

Customers'   Accounts, 

Real  Estate, 

Machinery,    Fixtures, 
etc., 

Investments, 


To  loss  by  Contingent 
Liabilities, 
"    Cash  drawn: 
First  year 
Second  year. 
Third  year,    


By  deficiency  as  shown  in 
statement   of  _  affairs, 
"    capital  originally  con- 
tributed, 
"    profit  shown  by 
books, 

First  year. 
Second  year. 
Third  year, 


Xn.    ATJDITINa  AOT)  REPOETINa. 

Object  of  an  Audit. 

In  the  earlier  part  of  this  volume  it  was  pointed  out 
that  the  accountant  as  such  performs  his  service,  not  as 


THE  PRINCIPLES  OF  ACCOUNTING         185 

a  bookkeeper  but  as  a  deviser  of  systems  of  accountings 
that  is,  for  recording  business  facts.  The  function  of  the 
bookkeeper  was  there  explained  as  being  that  of  setting 
down  or  recording  the  facts  relating  to  the  business  as 
they  developed  from  day  to  day  following  out  the  sys- 
tem which  the  accountant  had  devised  and  put  into  op- 
eration. It  was  noted  that  in  many  cases,  the  bookkeeper 
may  also  be  the  accountant  inasmuch  as  it  may  fall  to  him 
to  devise  the  system  of  accounting  in  the  first  place  or  to 
make  innovations  in  it  from  time  to  time  as  well  as  to  re- 
cord or  to  oversee  the  recording  of  the  daily  developments. 
A  different  kind  of  duty,  however,  falls  to  the  accountant 
— and  probably  more  frequently  than  does  that  of  originat- 
ing a  system  of  accounting.  This  is  what  is  known  as 
** auditing."  By  auditing  is  meant  a  process  of  ascertain- 
ing (1)  whether  a  given  set  of  accounts  or  system  of  ac- 
counting has  been  correctly  carried  out  in  a  formal  way — 
that  is  to  say,  whether  the  entries  have  been  correctly 
made  and  the  work  carried  on  without  fraud;  and  (2) 
whether  the  system  of  accounts  was  devised  originally  in 
such  a  way  as  to  furnish  the  information  that  is  needed 
in  order  to  give  a  correct  idea  of  the  business  or  whether 
it  was  so  crudely  framed  as  not  to  afford  an  accurate  no- 
tion of  what  has  actually  been  done.  Both  of  these  duties 
fall  to  the  accountant  and  in  performing  them  he  is  des- 
ignated as  an  *' auditor."  The  duty  of  auditing  accounts 
is  highly  important  both  from  the  legal  and  commercial 
standpoints,  and  the  necessity  of  having  some  supervis- 
ory authority  to  certify  to  the  results  of  the  accounting  is 
clearly  recognized  by  most  large  concerns  at  the  present 
time.  Moreover,  the  duty  of  auditing  accounts  is  now 
recognized  by  both  the  Federal  and  state  governments  in 
connection  with  the  performance  of  their  work  in  over- 
seeing the  operations  of  various  public  service  companies. 
Thus  the  Federal  Government  directs  the  accounts  of  na- 
tional banks,  railways,  etc.,  while  the  state  governments 


186  HENRY  PARKER  WILLIS 

direct  those  of  state  banks,  trust  companies,  insurance 
companies,  and  various  others,  and  not  a  few  municipali- 
ties do  the  same  with  respect  to  municipal  public  service 
corporations.  The  accountant,  when  called  in  for  consulta- 
tion by  a  commercial  concern,  may  be  asked  to  audit  the 
books  of  the  concern  merely  to  assure  the  managers  that 
everything  has  been  correctly  done  in  a  mechanical  way 
or  to  detect  fraud  which  is  supposed  to  exist  there,  or  he 
may  be  called  in  not  because  the  concern  thinks  there  has 
been  fraud  or  error  but  because  it  knows  there  has  not 
and  it  wants  the  accountant  to  certify  to  the  facts  in  the 
case.  Such  certification  is  growing  more  and  more  neces- 
sary as  an  element  in  the  granting  of  commercial  credit. 
Banks  and  other  financial  institutions,  before  granting  a 
loan,  ask  for  a  statement  or  audit  carried  on  by  a  certified 
public  accountant  in  order  that  they  may  be  assured  that 
the  business  is  in  exactly  the  position  it  claims  to  be.  If 
a  favorable  showing  is  made  the  bank  will  feel  safe  in 
making  a  loan  to  the  concern;  otherwise  not.  Thus  the 
function  of  auditing  has  a  most  important  financial  side. 
So  also,  an  executor  or  trustee  may  ask  to  have  his  ac- 
counts audited,  or  may  be  required  to  have  them  audited 
prior  to  his  being  released  from  the  responsibilities  of  his 
office.  In  all  these  ways,  auditing  involves  the  practical 
application  of  the  principles  of  accountancy  and  has  its 
relations  to  commerce,  finance,  and  legal  control. 

CHecking  tHe  Accounts. 

As  we  have  seen,  the  primary  function  of  the  audit 
is  simply  that  of  ascertaining  that  the  system  of  accounts 
originally  prescribed  or  embarked  upon  has  been  lived  up 
to  and  carried  out  on  the  basis  and  with  the  intent  origin- 
ally adopted.  This  evidently  involves  two  kinds  of  work — 
(1)  the  examination  of  the  entries  to  make  sure  that  they 
are  correct,  and  (2^  the  examination  of  the  other  data 
available  to  show  that  the  entries  were  warranted — that 


THE  PRINCIPLES  OP  ACCOUNTING         187 

is  to  say,  to  show  that  the  transactions  represented  actually 
occurred.  The  latter  point  may  be  considered  first.  This 
essentially  consists  in  a  checking  over  of  the  plant,  prop- 
erty, etc.,  to  see  that  it  is  as  stated.  Vouchers  for  pay- 
ments made,  contracts  showing  what  the  concern  is  en- 
gaged upon,  commercial  paper  showing  the  nature  of  its 
investments,  checks  evidencing  the  making  of  payments, 
may  be  examined  and  verified.  In  the  examination  of  a 
bank,  for  instance,  the  examiner  will  go  through  the  cash 
to  see  that  it  is  as  claimed,  will  glance  through  the  com- 
mercial paper  to  see  that  that  is  as  stated,  and  will  prob- 
ably communicate  with  the  correspondents  of  the  bank 
(other  banks)  in  order  to  ascertain  from  them  the  amount 
standing  upon  their  books  to  the  credit  of  the  bank  which 
he  is  examining.  In  the  case  of  the  business  firm,  he  may 
look  over  the  plant  in  a  general  way,  or  if  very  careful 
work  is  needed  he  may  secure  the  services  of  an  expert 
who  does  this  for  him  and  certifies  the  items,  values,  etc. 
In  the  case  of  the  ordinary  business  firm,  the  auditor  will 
want  to  assure  himself  that  the  cash  on  hand  and  in  bank 
is  as  represented  and  that  the  assets  or  goods  on  hand 
are  as  indicated  and  that  bills  payable  and  receivable  are 
as  stated.  Supposing  that  everything  is  correct  in  the  way 
of  vouchers,  property  on  hand,  commercial  paper,  etc.,  the 
auditor's  duty  in  checking  up  the  accounts  may  be  con- 
sidered. From  this  it  is  not  to  be  inferred  that  the  vouch- 
ers and  other  documents  are  examined  and  verified  first, 
before  checking  up  the  books,  although  they  may  be,  or 
the  verification  may  be  made  in  connection  with  the  ex- 
amination of  the  books.  When,  however,  the  task  of  check- 
ing up  is  begun,  the  auditor  cannot  of  course  go  through 
all  of  the  entries  to  see  item  by  item  that  the  several  en- 
tries are  correct.  He  will  endeavor  to  make  sure  funda- 
mentally that  the  bank  book  (written  up  by  the  bank) 
corresponds  with  the  bank  account  as  given  in  the  ledger, 
and  that  the  cash  book  corresponds  as  nearly  as  can  be 


188  HENRY  PARKER  WILLIS 

ascertained  with  the  bank  showing,  or  where  cash  has  been 
paid  out  on  voucher  that  it  corresponds  with  the  vouchers 
available.  He  will  endeavor  to  ascertain  whether  the  sub- 
ordinate books  such  as  invoice  book,  day  book,  etc.,  corre- 
spond with  the  entries  in  ledger  accounts,  testing  sample 
entries  and  verifying  the  accounts  showing  fixed  assets 
and  goods  so  far  as  possible  by  comparison  with  the  sub- 
ordinate books.  Profit  and  loss  account  will  be  examined 
with  particular  care  and  each  item  in  it  checked  back 
through  the  various  accounts  in  which  it  figures.  The 
same  will  be  done  with  the  balance  sheet,  in  order  to  make 
sure  that  that  is  likewise  as  represented.  If  this  has  been 
done  and  if  the  principal  outlay  accounts,  such  as  wages, 
etc.,  have  been  tested  by  comparing  the  entries  with  the 
subordinate  and  original  records  on  which  they  depend, 
the  auditor  will  probably  have  been  able  to  form  a  toler- 
ably correct  idea  of  the  records  of  the  business  as  such. 
Just  how  thorough  this  part  of  the  examination  should 
or  must  be  is  not  a  matter  which  can  be  expressly  stated. 
It  is  a  matter  for  agreement  between  the  parties  to  the 
audit,  and  the  degree  of  thoroughness  to  be  had  in  check- 
ing up  the  mere  mechanical  records  of  the  business  will 
depend  very  much  upon  the  extent  to  which  the  auditor 
is  given  time,  either  personally  or  through  others,  to  test 
the  various  records.  Although  he  can  ascertain  in  the 
ways  just  indicated  the  general  correctness  of  the  records 
it  is  entirely  possible  for  a  skilful  man  to  commit  frauds 
and  to  cover  them  up  by  fraudulent  entries  which  the 
auditor  cannot  ordinarily  detect  except  by  going  over  the 
work  in  great  detail.  For  example,  the  personal  ledger 
of  a  large  concern  or  the  depositors'  ledger  of  a  bank  may 
be  made  the  medium  of  a  fraud  which  is  practically  im- 
possible of  detection  in  the  ordinary  audit.  If  A  is  a  de- 
positor at  bank  I  and  brings  $100  in  funds  to  the  bank, 
the  teller  who  receives  it  will  enter  it  in  his  pass  book 
as  $100.    The  depositor  will  look  at  the  entry  and  go  away 


THE  PRINCIPLES  OF  ACCOUNTING         189 

satisfied.  If  the  teller  wishes  to  defraud,  he  may  enter 
the  customer's  account  with  $50  only,  making  the  corre- 
sponding entry  in  cash  and  keeping  the  extra  $50.  If  the 
customer  is  keeping  a  substantial  balance  at  the  bank  this 
may  be  perfectly  safe  from  the  immediate  standpoint.  The 
auditor,  going  over  the  books,  will  have  no  way  of  know- 
ing that  this  is  not  a  correct  entry  even  if  he  should  go 
through  .the  depositors'  ledger.  He  could  assure  himself 
only  by  calling  in  the  pass  books  and  comparing  them  with 
the  accounts — a  process  rarely  resorted  to.  The  frequency 
of  bank  frauds  shows  that  the  auditing  process  by  no 
means  always  attains  the  end  of  detecting  fraud  and  the 
same  is  true  in  other  classes  of  business.  Such  frauds, 
however,  are  likely  to  be  uncovered  at  almost  any  time 
through  some  circumstance  that  is  not  foreseen  and  that 
arouses  the  auditor's  suspicions  as  to  the  correctness  of 
the  work  he  has  been  asked  to  supervise.  Regularity  in 
audits,  therefore,  tends  strongly  to  the  avoidance  of  fraud. 

Protection  Against  Fraud. 

With  a  view  to  protecting  itself  against  fraud  the  well- 
organized  firm  usually  adopts  certain  safeguards  or  regu- 
lations regarding  the  conduct  of  its  accounting.  The 
au'ditors  when  going  over  the  accounts  naturally  become 
familiar,  early  in  the  process,  with  the  nature  of  such  safe- 
guards and  are  thereby  saved  from  the  necessity  of  doing 
work  designed  to  test  matters  that  have  already  been 
sufficiently  taken  care  of  through  the  office  regulations. 
Some  of  the  obvious  rules  that  are  ordinarily  adopted  for 
the  sake  of  protecting  the  concern  and  facilitating  audits 
are  those  of  (1)  making  complete  separation  between  the 
keeping  and  handling  of  the  cash  and  the  conduct  of  the 
personal  accounts  and  ledgers;  (2)  the  regular  payment 
into  the  bank  of  all  cash  each  day  and  the  making  of  pay- 
ments to  creditors  by  check  only;  (3)  the  requiring  of 
actual  vouchers  for  all  cash  pajnnents  not  made  by  check; 


190  HENRY  PARKER  WILLIS 

(4)  the  adoption  of  some  system  for  certifying  the  cor- 
rectness of  invoices  representing  goods  shipped;  and  (5) 
the  frequent  changing  of  employes  in  charge  of  various 
branches  of  the  work  in  order  that  each  man  may  have 
an  opportunity  of  testing  or  observing  the  work  of  other 
men  and  may  be  deprived  of  the  opportunity  of  commit- 
ting fraud  and  covering  it  up  by  continuous  bookkeeping 
entries  designed  for  that  purpose  either  individually  or 
jointly  with  others.    While  of  course  the  fact  that  such 
precautions  have  been  taken  and  that,  so  far  as  possible, 
the  business  itself  has  protected  itself  against  fraud  will 
tend  to  reassure  the  mind  of  the  examiner  of  accounts 
who  is  called  in,  the  mere  superficial  existence  of  the  de- 
sirable regulations  does  not  mean  that  they  have  been  lived 
up  to.    Also  the  auditor  may  observe  conditions  which  will 
in  his  judgment  make  it  necessary  for  him  to  disregard 
the  regulations  thus  apparently  set  in  force  and  to  con- 
duct his  examination  with  exactly   the   same   degree   of 
thoroughness  that  he  would  have  employed  had  he  not 
been  informed  of  the  existence  of  the  system  of  protec- 
tion in  the  office.    In  fact,  as  a  rule,  the  auditor  will  find 
it  desirable  to  assure  himself  that  such  a  system  of  pro- 
tection has  really  been  kept  in  rigid  operation,  since  in 
many  places  the  fact  that  the  system  exists  will  be  regarded 
by  careless  managers  as  exempting  them  from  the  neces- 
sity of  exercising  the  same  care  that  they  otherwise  would 
have  taken.    Where  a  system  for  the  prevention  of  fraud 
has,  however,  been  in  operation  along  the  lines  already 
indicated,  it  is  not  a  difficult  matter  for  the  auditor  to  see 
whether  it  has  in  the  main  been  effectively  applied  or  not. 
In  order  to  guard  against  the  danger  of  fraud  in  connec- 
tion with  the  audit  itself,  the  auditor  should  not  allow  the 
mechanical  operations  of  testing  the  accounts  to  be  car- 
ried on  by  the  employes  who  have  been  responsible  for 
them.    This  point  is  not  always  observed,  particularly  in 
connection  with  the  auditing  of  the  accounts  of  corpora- 


THE  PRINCIPLES  OP  ACCOUNTING         191 

tions  which  are  subject  to  public  control  and  where  the 
mere  mechanical  labor  of  going  through  the  books  is  great. 
In  the  case  of  the  national  bank  examinations,  for  example, 
it  has  frequently  been  found  that  the  examiner  was  in  the 
habit  of  calling  upon  the  clerks  themselves  to  make  out 
statements  concerning  their  own  operations.  Of  course 
this  gave  them  the  chance,  which  in  some  cases  was  availed 
of,  to  protect  themselves  by  providing  against  the  recog- 
nition of  their  errors,  furnishing  such  figures  to  the  auditor 
or  examiner  as  were  necessary  for  their  own  purposes. 

Responsibilities  of  Auditor. 

The  responsibilities  of  an  auditor  may  be  said  to  be 
both  legal  and  commercial.    Under  the  English  companies' 
act,  as  well  as  under  the  decisions  of  the  English  courts, 
the  functions  of  the  auditor  have  been  very  carefully  de- 
fined from  the  legal  standpoint   and   his   responsibilities 
have  been  marked  out.     Somewhat  the  same  has  been 
done    by    legislation    in    the    United    States.      An    aud- 
itor's  certificate   that  he  has   examined  the   books   and 
accounts    of    the    concern    and    has    found    its    balance 
sheet   to   be    accurate   is    accepted    as    a    definite    assu- 
rance that  all  is  correct  and  on  this  depends  his  pro- 
fessional reputation.     A  wilful  certification  to  what  he 
knows    to  be  untrue  may  be  disastrous  to  innocent  in- 
vestors, creditors  or  others  and  where  it  can  be  proved  is 
of  course  an  act  subject  to  severe  punishment  on  the  ground 
of  fraud.    In  some  English  cases  where  the  auditor  has 
been  found  to  be  guilty  of  negligence,  he  has  been  held 
jointly  liable  with  the  directors  for  moneys  lost  or  im- 
properly paid  as  the  result  of  such  negligence.    The  audit- 
or may  have  no  property  that  is  sufficient  to  meet  the  lia- 
bility thus  incurred,  which  may  be  very  large,  and  the 
point  may  thus  be  of  academic  rather  than  of  practical 
interest.     The  professional  reputation  of  the  well-estab- 
lished accountant,  however,  being  at  stake  whenever  he 


192  HENRY  PARKER  WILLIS 

makes  an  audit,  there  is  sufficient  inducement  to  warrant 
his  doing  what  he  can  to  secure  a  correct  showing  and  any; 
improper  collusion  between  the  auditor  and  the  concern 
for  which  he  is  working  would,  when  demonstrated,  en- 
tirely destroy  the  value  of  his  future  certificates  of  audit, 
as  well  as  inflict  upon  him  the  loss  of  his  professional 
standing  and  in  some  cases  legal  penalties  as  well. 

When  an  audit  has  been  completed,  it  is  customary 
for  the  auditor  to  make  out  and  sign  a  certificate.  This 
certificate  gives  the  name  of  the  auditor  and  may  simply 
certify  that  the  balance  sheet  has  been  found  to  be  a  cor- 
rect representation  of  the  affairs  of  the  business  or  it  may 
also  certify  that  the  audit  has  included  the  inspection  of 
the  property,  and  the  ascertainment  that  the  items  of 
property  claimed  are  on  hand  just  as  asserted.  How  ex- 
tensive the  audit  shall  be  and  consequently  how  extensive 
the  certificate  can  be,  is  a  matter  depending  upon  the 
scope  of  the  agreement  made  between  the  auditor  and  the 
concern  originally  and  the  work  the  auditor  has  been  en- 
gaged to  do.  The  auditor  if  simply  employed  to  look  over 
the  books  and  report  will  properly  regard  it  as  no  part 
of  his  duty  to  explain  to  the  directors  what  changes  should 
be  made  in  order  to  put  their  accounting  system  upon  a 
suitable  basis  or  what  methods  should  be  adopted  in  order 
to  improve  the  organization  of  the  business. 

Report  on  Condition  of  Business. 

In  many  cases,  however,  while  the  balance  sheet  is  tol- 
erably correct  as  a  representation  of  conditions  and  as 
showing  that  the  actual  accounting  has  been  honestly  and 
accurately  carried  on,  it  may  appear  as  the  result  of  the  in- 
quiry that  the  actual  condition  of  the  business  as  a  profit- 
making  concern  is  not  fully  exhibited  or  that  there  are  con- 
ditions growing  out  of  the  organization  of  the  concern  or 
the  nature  of  its  competition  with  others  and  the  like  that 
tend  to  make  the  values  exhibited  by  the  books  nominal 


THE  PRINCIPLES  OF  ACCOUNTINa         193 

rather  than  real.  In  such  cases,  if  the  auditor  has  been  em- 
ployed in  order  to  ascertain  the  real  worth  of  the  business 
as  a  going  concern,  his  duties  may  broaden  out  very  consid- 
erably and  it  may  be  a  part  of  his  responsibility  in  the  larg- 
er sense  of  the  term  to  make  a  report  upon  the  question 
whether  the  concern  can,  as  things  stand,  be  expected  to 
go  on  doing  the  same  in  the  future  as  it  has  in  the  past. 
The  inquiry  is  now  developed  into  a  general  discussion 
of  investment  and  competition,  just  as  the  devising  of 
an  accounting  system  in  the  first  place  may  frequently 
broaden  into  a  discussion  of  business  organization.  Under 
such  conditions  the  duties  of  the  auditor  are  those  of  a 
business  adviser  or  an  adviser  on  investments,  and  cannot 
be  exactly  defined.  Much  will  depend  upon  the  general 
judgment  of  the  auditor  in  such  cases  and  the  extent  of 
the  confidence  reposed  in  him  by  the  persons  who  have 
employed  him.  This  is  particularly  the  case  in  those  in- 
stances where  an  auditing  firm  or  auditor  has  been  em- 
ployed to  visit  a  certain  business,  investigate  it,  and  find 
out  whether  it  will  be  well  for  a  prospective  purchaser 
to  share  in  the  enterprise  as  he  perhaps  contemplates  doing. 

Examples  of  an  Audit. 

The  principles  which  have  been  laid  down  in  general 
terms  in  the  foregoing  part  of  this  section  are,  as  has  been 
stated,  incapable  of  specific  application  as  definite  rules  of 
thumb  to  any  particular  business,  because  of  the  fact  that 
businesses  vary  so  widely  in  the  details  of  their  accounts, 
in  the  number  of  books  which  they  keep  or  omit,  and  in 
the  actual  methods  of  filing  vouchers,  invoices,  and  original 
records  of  various  kinds.  In  order  to  illustrate,  however, 
with  greater  definiteness  the  actual  working  of  an  audit, 
attention  may  be  given  to  the  methods  by  which  a  bank 
examination  is  conducted.  This  is  possibly  the  best  illus- 
tration that  can  be  afforded  of  the  making  of  a  detailed 

audit  because,  as  has  already  been  said,  the  principles  upon 
B— VIII— la 


194  HENRY  PARKER  WILLIS 

wMch  bank  accounts  must  be  kept  have  been  set  forth 
with  considerable  detail  in  law,  and  absolute  uniformity 
is  required  under  the  national  banking  act.  Somewhat 
the  same  is  true  of  the  work  done  imder  the  direction  of 
the  Interstate  Commerce  Commission  in  connection  with 
railroad  accounts.  The  bank  audit,  however,  affords  the 
most  concise  and  comprehensible  illustration.  The  auditor 
who  is  called  upon  to  make  a  bank  examination  will  first 
select  a  department  of  the  bank  with  which  to  start.  He 
will  probably  begin  with  the  department  of  the  bank  in 
which  cash  is  received  by  the  receiving  teller.  Here  he 
will  actually  count  the  cash  and  ascertain  whether  it  agrees 
with  the  amount  indicated  in  the  teller's  own  record.  He 
will  then  look  over  the  checks  that  have  been  received 
and  the  checks  that  are  to  be  cleared  through  the  clearing 
house  and  will  ascertain  whether  they  have  been  prop- 
erly entered  on  a  clearing-house  sheet.  He  will  examine 
the  checks  that  have  been  deposited  and  will  compare  their 
amount  plus  that  of  the  cash  and  the  items  held  for  col- 
lection on  other  banks  to  see  that  they  are  equal  to  the 
total  amount  of  deposits  received  for  the  day.  Where  the 
auditor  comes  periodically  to  the  bank  and  is  more  or  less 
familiar  with  the  signatures  of  depositors,  he  will  bear  in 
mind  the  question  whether  all  checks  seem  to  be  bona 
fide.  The  examiner  in  entering  the  department  of  the 
bank  where  cash  is  paid  will  verify  the  cash  as  before  and 
will  examine  the  checks  paid  during  the  day  on  which 
he  makes  the  examination,  ascertaining  that  the  total 
amount  paid  is  the  same  as  is  indicated  on  the  books.  He 
will  further  find  out  whether  cash  on  hand  plus  the  amount 
of  checks  cashed  during  the  day  plus  amounts  charged  to 
other  departments  of  the  bank  agrees  with  the  total  cash 
held  on  the  previous  day  at  the  end  of  business.  Of  course 
incidentally  the  items  charged  to  other  departments  of 
the  bank  and  the  vouchers  for  currency  paid  or  shipped, 
etc.,  will  be  verified.    A  similar  process  will  be  carried 


THE  PEINOIPLES  OP  ACCOUNTING         195 

out  in  any  other  departments  into  whicli  tlie  bank  may- 
be divided  for  the  purpose  of  receiving  or  paying  funds; 
or  if  the  bank  is  a  small  institution  and  its  paying  and 
receiving  officers  are  the  same,  the  test  will  be  correspond- 
ingly modified  so  as  to  include  the  various  classes  of  op- 
erations performed.  The  question  of  payments  and  re- 
ceipts of  cash  and  cash  items  having  been  considered  by 
the  examiner,  he  may  devote  his  attention  to  the  discounts 
of  the  bank.  Here  the  fundamental  inquiry  will  be  that 
of  ascertaining  whether  the  record  of  discounts  corre- 
sponds with  the  accounts  in  the  general  ledger  posted  there- 
from; or,  if  paper  has  been  sent  away  for  the  purpose  of 
collection  or  some  similar  purpose,  it  will  be  necessary  to 
ascertain  that  the  representations  made  concerning  such 
paper  are  correct.  The  auditor  will  also  examine  the  ques- 
tion of  the  adequacy  of  the  security  and  if  he  has  reason 
to  think  that  given  paper  is  bad  or  doubtful  he  will  make 
a  note  concerning  it.  If  loans  have  been  made  on  col- 
lateral he  will  verify  collateral  and,  in  eases  where  it  is 
insufficient  owing  to  shrinkage  of  value,  he  will  so  indicate 
in  his  report.  Passing  to  the  bookkeeping  division  the 
work  will  be  more  mechanical.  Here  the  task  will  be  that 
of  checking  depositors'  accounts  for  a  given  period  with 
the  receiving  department's  records,  and  the  accounts  in 
which  discounts  have  been  entered  with  the  records  of  the 
discount  department.  Similarly  the  individual  depositors' 
accounts  will  be  checked  up  in  comparison  with  the  sums 
paid  by  the  paying  teller,  and  depositors'  balances  will 
be  compared  with  the  showing  made  in  the  general  ledger. 
The  assets  of  the  bank  as  represented  by  securities  held 
will  be  verified  by  actual  examination  of  the  assets  in  com- 
parison with  the  accounts  relating  thereto.  Then  the  aud- 
itor can  examine  into  the  assets  which  are  represented 
by  accounts  with  other  banks,  with  the  Federal  Treasury, 
or  elsewhere,  which  can  be  done  by  writing  direct  to  the 
correspondent  banks,  the  Treasury,  etc.,  and  receiving  back 


196  HENRY  PARKER  WILLIS 

a  reply  stating  the  condition  of  the  accounts  referred  to. 
By  comparing  these  reports  with  the  figures  shown  in  the 
corresponding  accounts  on  the  books,  this  phase  of  the 
assets  is  sufficiently  dealt  with.  The  examiner  is  then 
in  position  to  make  out  a  report  to  the  Comptroller  of  the 
Currency  who  sent  him  to  the  bank.  This  he  does  on  a 
form  specially  provided  for  the  purpose  with  questions  and 
blank  spaces  for  the  filling  in  of  all  the  principal  data. 
A  reproduction  of  such  a  report  is  seen  on  pages  198  to  206, 
and  furnishes  a  good  example  of  an  auditor's  report  of  this 
kind.  What  has  been  said  of  the  problem  of  bank  examina- 
tion holds  equally  true  of  other  classes  of  concerns  except 
that,  in  the  several  classes,  the  problems  differ  from  one  an- 
other because  of  the  different  character  of  the  assets  and 
the  varying  importance  assignable  to  various  accounts.  All 
this  makes  it  necessary  to  vary  the  degree  of  stress  laid 
by  the  auditor  upon  different  phases  of  the  auditing  ac- 
cording to  the  varying  character  of  the  business  which 
he  is  called  in  to  examine. 

Analyses  of  Accounts. 

While,  as  has  been  said,  the  auditor's  duty  may  end 
with  merely  ascertaining  and  certifying  the  correctness  of 
the  w^ork  done  or,  beyond  this,  the  truthfulness  of  the 
showing  made  as  to  assets  and  liabilities,  profits  and  losses, 
one  or  both,  the  auditor  may  be  asked  to  do  more  than  this 
or  in  connection  with  his  work  he  may  have  opportunity 
or  find  it  necessary  to  go  further  than  this  by  analyzing 
the  different  accounts  that  are  submitted  to  him.  Such 
analyses  are  needed  for  the  purpose  of  showing  what  is 
the  composition  of  a  given  account — that  is  to  say,  what 
elements  have  gone  into  it  and  from  what  sources  they 
have  been  drawn.  For  example,  ''expenses''  may  cover  a 
multitude  of  things  including  expenses  of  various  legiti- 
mate kinds  and  others  of  a  less  legitimate  character.  The 
analysis  will  show  a  grouping  of  items  by  classes.    That 


THE  PRINCIPLES  OP  ACCOUNTINa         197 

is  to  say,  the  account  may  be  broken  up  into  a  series  of 
groupings  or  headings.  For  instance,  the  expense  account, 
referred  to  above,  may  be  broken  up  into  different  classes 
of  expenses  whose  totals  will  be  the  same  as  the  totals 
shown  in  the  combined  account  on  the  books.  This  may 
be  a  desirable  thing  for  the  auditor  to  undertake  for  the 
purpose  of  testing  the  accuracy  of  the  statements  and  es- 
pecially for  ascertaining  whether  improper  entries  have 
been  made  in  the  accounts.  By  summarizing  the  analyzed 
results  of  an  extensive  account,  important  inferences  may 
be  drawn  regarding  outlays  which  are  growing  dispropor- 
tionately large  or  are  tending  to  outrun  the  capacity  of 
the  business  or  are  affording  an  opportunity  for  fraud. 
It  is  desirable  also  in  such  analyses  at  times  to  indicate 
where  the  different  items  were  drawn  from  in  the  sub- 
ordinate books.  Such  analyses  are  frequently  made  by 
the  auditor  for  the  purpose  of  ascertaining  whether  given 
instructions  have  been  obeyed  or  given  legal  requirements 
have  been  lived  up  to  in  connection  with  expenditures. 
As  a  result  of  such  analyses  of  extensive  and  inclusive  ac- 
counts, the  auditor  is  then  in  position  to  render  a  report 
showing  whether  the  requirements  in  mind  have  been  ob- 
served, whether  the  accounting  may  not  well  be  changed 
and  systematized,  and  whether  the  analyses  do  not  show  a 
necessity  for  alterations  in  business  practice  or  in  methods 
of  accounting. 

The  Auditor^s  Report. 

Reference  has  already  been  made  to  the  auditor's  re- 
port at  the  close  of  his  investigation.  As  will  be  gathered 
from  what  has  been  said,  such  a  report  varies  a  good  deal 
for  different  businesses.  For  every  business  there  will 
first  be  g:iven  an  outline  of  the  time  covered  and  the  orders 
under  which  the  audit  was  conducted,  then  the  statements 
which  are  included  and  any  general  remarks  about  the 
conditions  ascertained.    The  statements  included  will  cov- 


I9d  HENRY  PARKER  WILLIS 

er  in  tlie  case  of  the  ordinary  retail  establishment  balance 
sheets  for  the  opening  and  close  of  the  period  dealt  with, 
a  copy  of  profit  and  loss  and  trading  accounts,  and  lists 
of  bills  payable  and  bills  receivable,  and  frequently  ac- 
counts payable  and  receivable  at  the  time  the  audit  was 
concluded.  For  a  manufacturing  concern  there  will  be 
added  to  these  a  summary  statement  of  the  manufactur- 
ing account.  For  a  fiduciary  officer  whose  accounts  have 
been  audited  the  exhibits  needed  as  attached  statements 
will  be  the  balance  sheets  for  beginning  and  end  of  the 
time  covered,  a  statement  of  incomes  and  outlays,  and 
another  of  total  receipts  and  payments.  To  these  will  be 
added  a  careful  list  of  assets,  securities  owned,  etc.  Final- 
ly, the  auditor  will  append  a  certificate  to  the  effect  that 
he  has  audited  the  accounts,  books,  securities,  etc,  (omit- 
ting or  adding  such  items  as  have  not  or  have  been  exam- 
ined), that  he  has  checked  up  the  balance  sheet,  and  that 
the  sheet  indicates  the  true  condition  of  the  business  as 
shown  by  the  books.    (See  p.  192  foregoing.) 

The  following  reproduction  of  an  examiner's  outline  of 
report  on  condition  of  a  national  bank  gives  an  idea  of  the 
detailed  items,  knowledge  of  which  is  necessary  to  an  un- 
derstanding of  the  exact  condition  of  the  institution. 

No.  of  Bank,  

EXAMINER'S  REPORT 
of  the 

Condition  of  "The   " 

Located  at  ,  in  the  County  of  

State    of    

Examination  commenced  at   o'clock M.,  on   ,  190 

Examination  closed  at   o'clock  ....M.,  on  ,  190 

President ,  Cashier. 


THE  PRINCIPLES  OP  ACCOUNTINa 


199 


Resourcei. 

Amount, 

Liabilities. 

Amount 

1.  Loans   and    Discounts 

1.  Capital   Stock  paid  In, 

(see  schedule), 

2.   Surplus  Fund, 

2.  Overdrafts, 

3.  Other    Undivided    Profits, 

3.  U    a    Bonds  to  secure 

viz: 

Clfpuiatlon    (     %), 

Discount.         % 

4.  U.    S.    Bonds   to   secure 

Exchange, 

Deposits    (     %), 

Interest, 

6.  TJ.   S.    Bonds   on  hand 

Premiums, 

6.  Preniiuin   on   U.    S.    Bonds, 

Rents, 

Profit  and  Lorr, 

7.  Bonds,     Securities,    etc. 
(see  schedule). 

4.  Due     to    applied    Reserve 
AgentSt  viz: 

8.  Banking  House,  $ 

Furniture  and 

Fi'^turofl 

9.  Other    Real    Estate    Owned 

(see    schedule). 

10.  Due     from     app'd    Reserve 

Agents,    viz: 

11.  Due    from    other    National 

Banks, 

1.  Due      to      other      National 

12.  Due   from   State  Banks, 

Banks, 

and   Bankers, 

6.  Due    to    State    Banks    and 

13.  Due  from  Trust  Companies 

Bankers, 

and     Savings     Banks     and 

7.  Due     to    Trust     Companies 

Foreign    Exchange, 

and      Savings     Bank     and 

14.  Exchanges      for      Clearing 

Foreign    Exchange, 

House, 

8.   Dividends    unpaid. 

15.  Checks     on     other     Banks 

9.  Individual    Deposits,  viz: 

in   same   place. 

16.  Bills      of     other      National 

Banks, 

Subject  to 

17.  Uncurrent  and  Minor  Colna, 

Check,                  $ 

18.  Cash   Items, 

Savings  Deposits, 

JX' 

Demand  Cert's, 

a 

Time  Cert's, 

« 

Certified  Checks. 

K 

Fractional 
Silver,     % 

r'flfll^iAr'B  r?hprk«, 

s 

Silver 

o 

Dollars, 

10.  United  States   Deposits, 

1 

Silver 

11.  Deposits   of  U.    S.    Disburs- 

Certificates, 

ing  Officers, 

s 

Gold    Coin, 

pt; 

Gold 

Certificates, 

13.  Circulation 

fe 

Legal-Tender 

received,            $ 

4> 

Notes, 

Less    on  hand 

Gold  Cert's 
payable  to 

and    returned. 

S 

order. 

■g 

C.  H.  Cert'a 

18.  State      Bank      Circulation 

1 

of  Dep., 

outstanding. 

14.  Notes      and      Bills      redis- 

counted. 

15.  Bills    payable, 

16.  Cash    over. 

2C 

.  5%       Red'n       Fund       with 
Treasurer  U.   S., 

17.  Loans     held    In     trust    for 
customers. 

21.  Other    Funds    with    Treas. 

U.    S.. 

22.  Current 

Expenses,          $ 

Taxes  paid. 

Interest  paid, 
23.  Cash  short. 

1 

24.  Loans    made    for    account 

of   customers. 

Total, 

Total. 

200 


HBNRY  PARKER  WILLIS 


Directors. 


No,  of  Bank, 


No.  of 
Shares 
Owned. 

Names. 

Post-Offlce 
Address. 

Liability 
as  Payers 

(individual 
or  firm), 
including 

overdrafts. 

Liability 
as  Joint 
Makers. 

Liability 
as 

Indorsers 

or 

Guarantors 

Occupatlom 

Total. 

1 

[Ascertain  from  record  book  how  often  directors  meet  as  a  board,  and  whether  they 
authorize  or  approve  loans  and  discounts  at  such  times;  whether  they  have  active  discount 
and  examining  committees,  or  leave  management  entirely  to  the  officers;  whether  annual 
meeting  of  shareholders  was  held,  and  whether  any  director,  other  officer,  clerk,  teller,  or 
bookkeeper  acted  as  proxy.  Any  vacancy  in  board  should  be  noted.  Opposite  the  name  of 
each  director  enter  full  amount  of  all  paper  in  bank  upon  which  his  name  (individual  or 
firm)  appears  as  maker,  indorser,  or  guarantor,  but  where  two  or  more  directors  are  liable 
on  the  same  paper  deduct  from  the  totals  the  duplicate  liabilities,  so  as  to  show  the  net 
liabilities  of  all  directors.] 

Officers  and  Employes. 


President, 

Vice-President, 

Cashier, 

Assistant  Cashier, 

Teller, 

Bookkieeper, 


Names. 


No.  of 
Shares 
Owned. 


Liability 
as  Payers 

(Individual 
or  firm), 
including 

overdrafts. 


Liability 

as 
Indorsers 


Guarantors 


Salary. 


Bond. 

(If  any.) 


Other 

Occupation 

(If  any.) 


[Examine  official  bonds;  state  form  of  bonds;  whether  In  force  and  In  whose  custody 
lodged;  whether  any  officer  or  clerk  of  the  bank  is  an  officer  or  clerk  of  any  savings  bank 
or  other  banking  institution  located  in  same  place;  which  employe  keeps  the  individual 
ledger;  whether  any  officer  or  employe  who  receives  deposits  makes  entries  in  the  in- 
dividual ledger;  whether  the  individual  ledger  bookkeeper  sometimes  acts  as  teller;  who 
balances  the  depositors'  pass  books,  and  whether  the  balances  are  compared  by  some  one 
other  than  the  Individual  ledger  bookkeeper;  which  employe  keeps  the  general  ledger, 
and  who  reconciles  bank  balances.] 


THE  PRINCIPLES  OF  ACCOUNTING 


201 


Books  and  Accounts. 

[Follow  Instructions  as  to  verification  of  accounts  and  state  specifically  whether  bank 
uses  the  daily  balance  system  for  Individual  ledger  accounts;  whether  the  ledgers  are 
properly  and  promptly  posted,  and  how  often  they  are  balanced;  how  often  loans  and 
discounts  are   verified,   and   how  often   accounts   with   corresponding   banks   are   reconciled.] 


RESOURCES. 


No.  of  Bank. 


1.  Loans  and  Discounts. 


[The  loans  and  discounts  and  other  securities  must  be  carefully  verified  and  every 

discrepancy  noted.] 


A. — On  demand,  paper  with  one  or  more  individual  or  firm  names,  $ 

B. — On  demand,  secured  by  stocks,  bonds,  and  other  personal  securities, 
C. — On   time,   paper  with   two  or  more   individual   or  firm  names, 
T>. — On    time,    single-name    paper    (one    person    or    firm)    without    other 

security, 
E. — On   time,   secured   by  stocks,   bonds,   and  other  personal   securities, 
F. — On   time,   secured  by  real   estate  mortgages  or  other   liens  on   realty 

(see  schedule). 

Total, 
Included    in   the   above  are — 
G. — Bad  debts,  as  defined  In  Section  5204,  Revised  Statutes  (see  remarks 

below), 
H. — Other  suspended  or  overdue  paper  (see  remarks  below), 


Total, 


Loans  exceeding  the  limit  prescribed  by  Section  5200  of  the  Revised  Statutes. 
Overdrafts,  if  any,  are  regarded  as  loans. 


Name  of 

Borrower. 

(State  value 

of  security 

and 

financial 

standing 

of  makers 

and  indorsers. ) 

Date. 

Enter  Full 
Amount 
of  Loan. 

Name  of 

Borrower. 

(State  value 

of  security 

and 

financial 

standing 

of  makers 

and  indorsers.) 

Date. 

Enter  Full 
Amount 
of  Loan. 

[Describe  the  general  character  of  loans  and  discounts,  particularly  those  reaching^ 
the  limit,  other  large  loans  and  loans  to  other  national  banks,  giving  date  and  maturity^ 
of  latter  loans;  state  whether  accommodations  are  well  distributed;  the  financial  standing 
of  makers  and  indorsers;  and  the  current  rate  of  interest  obtained.  If  any  director  or 
ofllcer  has  a  large  liability  as  payer  or  indorser,  state  whether  it  comprises  direct  loans, 
or  strictly  commercial  or  business  paper  discounted  for  him,  accommodation  paper  made 
by  others  for  his  use  and  indorsed  by  him,  or  accommodation  indorsements,  and  If  the 
latter,  state  whether  he  is  loaning  the  bank's  funds  on  real  estate  security  in  this  way  in 
his  name.  Describe  also  all  loans  and  discounts  to  corporations  or  enterprises  in  which 
directors  and  officers  are  interested.  State  whether  loans  are  secured  by  collateral,  and,  It 
Bo,  its  character  and  value.] 


Suspended  or  Overdue  Paper,  including  "bad  debts"  as  defined  by  Section  5204. 

[Describe  general  condition  of  such  paper,  state  how  secured  and  how  long  It  haa 
been  In  the  bank.  List  only  Items  on  which  loss  has  or  will  be  sustained  and  state  the 
amount  of  loss.] 


202  HENRY  PARKER  WILLIS 


RESOURCES— Continued. 

No.  of  Bank, 


2.  Overdrafts. 


[State  what  amount  is  unsecured,  and  whether  habitually  granted.  Overdrafts 
exceeding  limit  named  In  Section  5200  should  be  classed  with  Excessive  Loans,  and 
unsecured  overdrafts  which  have  remained  unchanged  for  six  months  or  longer  should  be 
noted.  The  amount  of  overdrafts  at  date  of  examination  should  be  verified  by  the  examiner, 
■who  should  also  compare  the  amount  of  overdrafts  stated  in  the  bank's  last  report  of 
condition  with  the  amount  shown  by  Its  books  at  same  date,  and  report  any  discrepancy 
discovered.] 


8.  Banking  House. 

[State  whether  suitable  and  convenient;  for  what  other  purpose  used  (If  anyl ;  and, 
If  owned  by  bank,  whether  carried  at  fair  value  on  books,  and  whether  building  is  insured; 
whether  vault  and  safe  are  good  and  secure,  and  used  by  the  bank  only;  whether  furniture 
and  fixtures  are  worth  book  value,  and  whether  any  savings  bank  or  other  banking  Institu- 
tion occupies  the  same  office  with  the  bank  under  examination.] 


10,  11,  and  12.     Due  from  Reserve  Agents,  Trust   Companies,  Banks,  and 
Bankers. 

[Verify  all  balances  by  correspondence  on  blanks  furnished  for  this  purpose,  but 
forward  report  promptly  without  awaiting  verification.  Any  discrepancies  which  may  be 
disclosed  should  be  reported  by  letter  afterward  If  they  can  not  be  reconciled  by  the 
examiner.  State  whether  bank  receives  Interest  on  any  balances,  and  at  what  rate.  If 
any  amounts  are  represented  by  certificates  of  deposit  issued  by  other  national  banks,  stite 
whether  they  are  secured  by  collaterala.  Verify  bills  in  transit,  foreign  bills,  and  other 
Items  not  in  custody  of  bank,  In  accordance  with  Instructions.] 


17.  Cash  Items. 

[State  whether  regular;  and  if  overdue  paper,  memorandum  loans,  checks,  dishonored 
drafts,   expense  items,  etc.,   are  carried  here,  briefly  describe  such  items.] 


18.  Reserve. 

[State  whether  reserve  (total  and  in  bank)  is  sufficient  at  date  of  examination:  the 
average  for  thirty  days  preceding,  where  practicable,  and  describe  Its  general  condition 
since   last  examination.] 

Are  national  bank  notes   separated  from  the  other  currency,  both  as  to 
counter  cash  and  currency  in  the  vault? 

If  not,  did  you  separate  them  at  the  time  of  the  examination? 

Is  an  exact  daily  record  kept  of  the  different  kinds  of  money  on  hand? 


THE  PRINCIPLES  OF  ACCOUNTING 


203 


RESOURCES— Continued. 


7.  Bonds,  Securities,  etc. 


No.  of  Bank. 


Enter   number  of' 
shares    of    stock  Name   of   corpo- 
face    value  of,       ration    Issuing 


bonds,  an<i  state 
whether  bonds 
or  stocks. 


stocks,    bonds, 
etc. 


Total, 


Amount     at 

which   carried 

on  books. 


Estimated 
actual    mar- 
ket value. 


State  whether  taken  for 
"debts  previously  con- 
tracted," or  otherwise, 
and  if  interest  or  divi- 
dends are  regularly  paid, 
etc. 


9.  Other  Real  Estate  Owned. 


Describe  property. 

Amount    at 

which 

carried 

on  books. 

Amount  of 
prior  lien 

on 

property. 

If  any. 

Estimated 
actual  value 
of  property. 

Date  when 
title  was 
acquired. 

State     whether 
taken    for    "debts 
previously   con- 
tracted,"   or 
otherwise. 

Total, 

Loans  and  Discounts  secured  by  Real  Estate  Mortgages  or  other  liens  on  realty. 


Give    name   of 

borrower   and 

form    of 

collateral. 

Amount 
of  loan. 

Amount 
of  prior 

lien  on 
property. 

If  any. 

Estimated 

actual 

value  of 

property. 

Date 

when 

security 

was  taken. 

State  whether 
taken     to     secure 
"debts     previous- 
ly   contracted," 
or   otherwise. 

Total, 

204  HENRY  PARKER  WILLIS 

LIABILITIES. 


No.  of  Bank, 


1.  Capital  Stock. 

[State  whether  stock  certificate  book  and  stock  ledger  are  properly  kept,  whether 
surrendered  certificates  are  properly  canceled  and  attached  to  stubs,  and  whether  stock 
certificates  are  signed  in  blank.  Verify  amount  of  stock  outstanding.  State  also  whether 
the  bank  owns  or  holds  as  collateral  for  loans  any  shares  of  its  own  stock,  and,  if  so,  for 
what  purpose,  and  give  date  when  taken.  In  the  case  of  a  new  bank,  ascertain  and  state 
whether  its  capital  has  been  paid  In  cash,  or  whether  any  shareholders'  notes  have  been 
taken  for  stock  subscriptions.] 


2  and  3.  Dividends  and  Surplus  (Sections  5199  and  5204,  U.  S.  Revised  Statutes). 

Date    of    last    dividend,  Amount,    |  Carried    to    Surplus,    ( 

Charged   oft  since   last   examination:    Losses,    $  Premium,    | 

Decrease  of  values,  | 

[State  If  any  reason  is  known  why  the  bank  should  not  declare  a  dividend  at  th» 
end   of   the    current   dividend   period.] 

[Compare  the  bank's  last  report  of  earnings  and  dividends  with  the  amount  of  profits 
shown  by  its  books  at  same  date,  and  report  any  discrepancy  discovered.  Report  all  profits 
irregularly  carried  on  individual  ledger,  in  special  accounts,  or  charged  off  the  books.] 


4,  5,  and  6.  Due  to  Reserve  Agents,  Trust  Companies,  Banks,  and  Bankers. 

[Verify  all  balances  by  correspondence  on  blanks  furnished  for  this  purpose,  but 
forward  report  promptly  without  awaiting  verification.  Any  discrepancies  which  may  be 
disclosed  should  be  reported  by  letter  afterward  if  they  can  not  be  reconciled  by  the 
examiner.  State  whether  amounts  are  due  on  open  account  or  on  demand  or  time  certif- 
icates of  deposit,  whether  secured  by  collaterals,  and  what  rate  of  Interest,  If  any,  is  paid.] 


8.  Individual  Deposits. 

[State  whether  interest  is  paid,  and,  if  so,  at  what  rates  and  to  what  extent; 
whether  certificates  of  deposit  are  irsued  for  the  purpose  of  borrowing  money,  and,  if  so, 
give  list  of  them,  under  13  and  14,  showing  amount  of  each  certificate,  to  whom 
Issued,  whether  payable  on  demand  or  on  time,  and  at  what  rate  of  Interest,  and  whether 
secured  by  collaterals  of  the  bank.  State  whether  a  proper  record  of  all  certificates  of 
deposit  issued  is  regularly  kept  in  a  book  for  that  purpose.  If  certificates  of  deposit  are 
Issued  to  other  national  banks,  give  full  information  regarding  them.  If  bank  conducts  a 
"savings"  department,  state  the  amount  of  such  deposits,  with  rate  of  interest  paid.  If 
bank  holds  State,  county,  municipal,  or  other  balances  subject  to  check,  which  will,  if 
suddenly  withdrawn,  seriously  reduce  Its  reserve,  state  the  amounts  and  rate  of  Interest 
paid.] 

13  and  14.  Rediscounts  and  Borrowed  Money. 

[Where  money  is  borrowed  by  rediscounts,  on  open  account,  or  otherwise,  state  below 
•where  and  when  accommodation  was  procured,  the  form  and  amount  of  obligation,  rate  of 
Interest  paid,  date  of  maturity,  and  whether  secured  by  collaterals  of  the  bank.  State 
also  whether  bank  borrows  habitually,  and  whether  such  liabilities  have  been  authorized 
by  board  of  directors.  If  borrowing  is  from  other  national  banks,  give  full  information 
concerning-   transactions   of    this   character,    Including   date   of   issue    and   maturity.] 


Recapitulation. 


[Wherever  it  appears  that  any  loss  has  been  sustained  or  is  probable  on  any  item, 
or  that  the  value  has  depreciated,  enter  the  book  value  of  such  item  or  items  in  schedule 
below,  together  with  estimated  probable  loss  thereon.  If  no  loss  is  probable,  indicate  that 
fact  by  the  word  "none."  In  every  report  enter  in  this  schedule  the  amount  of  surplus  and 
profits  on  hand  at  date  '>f  examination.] 


THE  PRINCIPLES  OF  ACCOUNTING 


205 


LIABILITIES— Continued. 

No.  of  Bank. 


IN  ALL  CASES  WHERE  LOSSES  ARE  ESTIMATED,  FURNISH 
ITEMIZED  LIST. 


Resources. 

Book 
Value. 

Probable 
Loss. 

Estimated 

Value  of 

Assets  not 

Shown  on 

Books. 

Surplus,  Undivided  Profits, 
Etc. 

''Bad  Debts," 
Other     overdue 

paper. 
Other  loans  and 

% 

$ 

$ 

Surplus  fund. 

Undivided  profits. 
Total, 

Less  current  ex- 
penses taxes, 
etc.. 

Total    Surplus 
and    Profits, 

i 

discounts, 
Overdrafts. 
Premiums    on    U. 

S.    bonds, 
Bonds,  securities, 

etc.. 
Banking  house, 
Furniture  and 

Other  real  estate, 
Cash    Items, 

Total, 

General  Remarks  as  to  Condition  of  Bank. 

[State  briefly  yonr  opinion  as  to  the  general  condition  of  the  bank,  and  whether  its 
business  is  prosperous  or  otherwise,  whether  ofRcers  are  capable,  prudent,  and  of  good 
reputation;  the  management  efficient  and  successful,  or  otherwise;  and  grive  summary  of 
matters  to  which  special  attention  shoald  be  called,  using  extra  sheet  if  necessary.] 

To    thv    Comptroller    of    the    Currency,  

WaBbington,  D.  C.  Examiner. 


206 


HENRY  PARKER  WILLIS 


IMPORTANT 


Please  answer  "yes"  or  "no"  to  each 
of  the  following  questions  as  to  ex- 
amination of  this  bank,  No 

over  your  signature. 

Did  you  count  the  cash,  as  Instructed? 

Did  you  examine  and  list  loans  and  dis- 
counts and  all  collateral  held  therefor,  as 
Instructed? 

Did  you  note  all  loans  and  discounts  to 
directors  and  officers,  and  to  enterprises  In 
which    they   are    interested,    as   instructed? 

Did  you  examine  and  list  all  stocks,  se- 
curities, etc ,  held  by  bank,  and  all  real 
estate  and  mortgages  owned  or  held  by  it, 
and  Treasurer's  receipt  for  U.  S.  Bonds,  as 
ir.Linicted? 

Did  you  take  off  or  verify  a  balance  of 
accounts   on   Individual    ledger   or   ledgers? 

Did  you  check  off  last  statements  re- 
ceived from  corresponding  banks  and  find 
them    correct? 

Did  you  verify  outstanding  certificates 
of  deposit,  certified  checks,  and  cashier's 
checks,   as  Instructed? 

Did  you  take  off  balance  of  stock  ledger 
and  examine  stock  certificate  book,  as  in- 
structed? 

Did  you  examine  profit  and  loss  and  ex- 
pense accounts,   as  instructed? 

Did  you  examine  minutes  of  directors* 
meetings,  discount  committee  meetings,  and 
shareholders'  meetings,  as  instructed? 

Did  you  examine  into  condition  of  lawful 
money  reserve  for  thirty  days  preceding 
examination? 

Did  you  compare  bank's  copy  of  last  re- 
port of  condition  to  Comptroller  with  Its 
books  at  same  date? 

Have  you  sent  out  verification  circulars 
(Form   2193)    as  follows: 

1.  To  all  banks  and  bankers  to  which, 
or  from  which,   balances  are  due? 

2.  To  all  parties  from  whom  money  has 
been  borrowed  on  bills  payable,  certificates 
of  deposit,   or  notes  and  bills  rediscounted? 

3.  To  all  parties  to  whom  items  have 
been    sent    for    collection? 

4.  To  all  officials  in  whose  names  State, 
county,    or   municipal    funds   are    deposited? 

5.  To  the  U.  S.  Treasurer  (care  of  N. 
B.  Redemption  Agency)  for  verification  of 
6  per  cent  fund  OQ  Form  2196. 


NOTICE.—  Fold  pages  together  but 
do  not  use  any  fasteners. 


«^Fill  Indorsement  with 
Typewriter. 


No.    of    Bank, 

EXAMINER'S  REPORT 
of 


The. 


Located  at 


.,190 


Examiner 


Examiner. 


PART  II. 

INTRODUCTION. 

In  the  following  pages  it  has  been  sought  to  compile 
material  that  will  be  of  service  to  the  student  who  desires 
a  comprehensive  knowledge  of  accounting  problems  as 
practically  presented.  Inasmuch  as  readers  of  this  volume 
may  be  desirous  of  taking  and  passing  accountancy  exam- 
inations, the  first  section  of  this  Part — Section  A — deals 
with  sundry  suggestions  for  study  and  with  methods  of  pre- 
paring for  such  examinations.  Several  sets  of  examination 
questions  are  given,  all  being  drawn  from  the  questions 
set  at  various  times  by  the  New  York  board  of  accountancy 
examiners. 

In  Section  B  is  reproduced  the  outline  of  accounting 
terms  which  has  been  prepared  for  the  United  States  Gov- 
ernment as  a  preliminary  to  the  study  of  its  statistics  of 
cities.  The  summary  treatment  here  given  is  of  special 
value  in  differentiating  public  and  municipal  accounting 
from  commercial  and  private  accounting.  A  considerable 
number  of  terms  are  clearly  defined  which  have  not  been 
treated  in  Part  I  of  the  present  volume,  and  the  discus- 
sion, it  is  therefore  believed,  will  be  of  service  in  supple- 
menting the  material  already  presented.  In  Section  C 
is  given  material  dealing  directly  with  governmental  meth- 
ods of  accounting,  one  monograph  on  federal  accounting 
being  reproduced. 

In  Section  D  is  given  a  treatment  of  the  new  federal 
corporation  tax  and  its  application  to  corporation  account- 

207 


508  HENRY  PARKER  WILLIS 

ing.  This  is  a  field  of  accounting  which  has  assumed  large 
importance  in  England,  and  in  other  coimtries  where  taxa- 
tion has  necessitated  the  keeping  of  accounts  in  specified 
ways.  The  field  is  comparatively  new  in  the  United  States 
and  it  is  therefore  deemed  wise  to  present  first  the  law 
applying  the  corporation  tax  and  the  regulations  under 
which  the  Federal  Government  has  sought  to  put  it  into 
effect.  There  is  also  offered  a  treatment  of  the  accounting 
phases  of  the  subject  by  a  student  of  recognized  standing. 
In  Section  E  is  presented  an  outline  treatment  of  cost 
accounting  in  which  public  and  private  methods  of  cost 
keeping  are  theoretically  considered.  This  may  with  profi.t 
be  read  in  connection  with  the  section  on  the  same  subject 
given  in  Part  I  of  the  present  volume. 

An  additional  exposition  of  some  of  the  more  difficult 
principles  of  the  subject  has  also  been  reproduced.  In 
Section  F  three  Federal  Supreme  Court  decisions  ren- 
dered in  cases  involving  accounting  questions  are  offered 
in  order  that  the  student  may  familiarize  himself  with 
the  lines  of  reasoning  employed  by  the  courts  in  adjudicat- 
ing accounting  questions.  The  work  of  the  courts  has  be- 
come exceedingly  significant  in  connection  with  account- 
ing issues  abroad,  and  is  likely  to  become  progressively 
more  so  in  the  United  States.  In  Section  Gr  is  given  matter 
relating  to,  or  descriptive  of,  certain  phases  of  standard  sys- 
tems of  accounts.  A  part  of  this  matter  is  drawn  from  the 
balance  sheet  prescribed  for  the  railroads  of  the  United 
States  by  the  Federal  Government,  and  a  part  from  a  sys- 
tem put  into  effect  by  a  large  and  highly  organized  private 
company.  The  student  will  profit  from  an  examination  of 
these  systems  of  accounting  in  conjunction  with  the  sec- 
tion on  corporation  and  manufacturing  accounting  offered 
in  Part  I  of  the  present  volume. 

Very  sincere  thanks  are  due  the  Editor  of  the  Journal 
of  Accountancy,  the  Editor  of  the  Government  Accountant, 
the  Editor  of  the  Yale  Review,  Hon.  LeGrand  Powers, 


INTRODUCTION  ^09 

TT.  S.  Census,  and  Hon.  Lawrence  0.  Murray,  Comptroller 
of  the  Currency,  for  permission  to  use  matter  presented 
in  this  Part. 

Particular  acknowledgment  should  also  be  made  to  the 
several  of  those  whose  work  is  reprinted  here,  for  the  per- 
mission and  encouragement  they  have  given  the  present 
compiler,  in  reproducing  their  writings. 


B—vni— 14 


SECTION  A. 

WORKS  FOR  THE  STUDY  OF  ACCOUNTING. 

Chase,  Auditing  and  Cost  Accounting  (LaSalle  Exten- 
sion University). 

Cole,  Accounts,  (Houghton  Mifflin  &  Go.)^ 

Dicksee,  Bookkeeping  for  Accountant  Students,  (Gee  & 
Co.,  London).^ 

Dicksee,  Advanced  Accounting,  (Gee  &  Co.,  London).^ 

Grierson,  Bookkeeping  for  Commercial  Classes,  (Blackie  & 
Co.,  Edinburgh).^ 

Grierson,  Advanced  Bookkeeping,  (Blackie  &  Co.,  Edin- 
burgh)." 

Hatfield,  Modern  Accounting,  (Appleton  &  Co.).^ 

Keister,  Corporation  Accounting,  (Burrows  Bros.).^ 

Lisle,  Accounting  in  Theory  and  Practice,  (William  Green 
&  Sons,  Edinburgh).^ 

Lisle,  Cyclopaedia  of  Accounting,  (William  Green  &  Sons, 
Edinburgh)."^ 

Sprague,  Philosophy  of  Accounts,  (Published  by  Author, 
N.  Y.  City).^ 

The  Accountants  Library,  (Gee  &  Co.,  London).^"* 


1.  Should  be  studied  by  reader  of  the  present  volume  in  conjunction  there- 

with,   unless    he    already    has    a    knowledge    of    bookkeeping    principles 
and  practice. 

2.  Should  follow  the  preceding  for  use  with  the  present  volume. 

3.  May  be  substituted  for  the  works  referred  to  in  Notes  1  and  2. 

4.  May  be  read  collaterally  with  the  present  volume  by  those  who   desire 

fuller  exposition  of  details  and  discussion  of  matters  not  dealt  with  in 
the   present  volume. 

5.  May  be  read  as  collateral  if  desired. 

6.  Affords   valuable    detailed   information    on    special   phases    of  accounting. 

7.  Authority  on  all  phases  of  accounting  theory  and  practice. 

8.  May  be  consulted  on   special  phases  of  corporation  accounting  practice. 

9.  Of  service  on  some  of  the  more  abstract  questions  of  accounting  theory. 
10.     A  series  of  reliable  monographs  on  the  accounting  problems  of  various 

classes  of  business. 

210 


ACCOUNTANCY  EXAMINATIONS. 

While  the  study  of  accountancy  is  of  fundamental  value 
to  those  who  have  accountancy  systems  to  install  or  who 
are  concerned  with  the  business  of  conducting,  and  improv- 
ing upon,  sets  of  books,  there  is,  as  has  been  noted  in  the 
earlier  part  of  this  volume,  a  growing  demand  of  a  new 
sort  for  expert  knowledge  of  accounting.  This  demand  is 
afforded  by  what  is  now  called  the  accoimtancy  profes- 
sion whose  demands  and  functions  have  been  sketched  in 
general  terms  in  Part  I  of  the  present  book.  It  is,  there- 
fore, important  to  many  students  of  accounting  to  know 
how  and  under  what  conditions  they  can  gain  admission 
to  the  profession  of  accountancy  and  under  what  circum- 
stances the  practice  of  that  profession  is  best  carried  on. 

The  present  tendency  is  toward  the  regulation  and  con- 
trol of  the  accountancy  profession  by  two  methods:  (1) 
State  legislation  and  (2)  private  organization  among  ac- 
countants : 

State  Legislation. 

The  State  of  New  York  passed  the  first  law  relating 
to  accountancy  in  1896.* 

*The  New  York  Certified  Public  Accountant  law,  which  may  be  regarded 
as  tyoical,  is  as  follows: 

Section  1.  Any  citizen  of  the  United  States,  or  person  who  has  duly  de- 
clared his  intention  of  becoming  such  citizen,  residing  or  having  a  place  for 
the  regular  transaction  of  business  in  the  state,  being  over  the  age  of  twenty- 
one  years  and  of  good  moral  character,  and  who  shall  have  received  from  the 
regents  of  the  university  a  certificate  of  his  qualifications  to  practice  as  a 
public  expert  accountant  as  hereinafter  provided,  shall  be  styled  and  known  as 
a  certified  public  accountant;  and  no  other  person  shall  assume  such  title,  or 
use  the  abbreviation  C.  P.  A.  or  any  other  words,  letters  or  figures,  to  indicate 
that  the  person  using  the  same  is  such  certified  public  accountant. 

Section  2.  The  regents  of  the  university  shall  make  rules  for  the  examma- 
tion  of  persons  applying  for  certificates  under  this  act,  and  may  appoint  a 
board  of  three  examiners  for  the  purpose,  which  board  shall,  after  the  year 
eighteen  hundred  and  ninety-seven,  be  composed  of  certified  public  account- 
ants. The  regents  shall  charge  for  examination  and  certificate  such  fee  as  may 
be  necessary  to  meet  the  actual  expenses  of  such  examinations,  and  they  shall 

Sll 


212  ACCOUNTANCY  EXAMINATIONS 

In  1899  a  statute  designed  for  the  same  purpose  as 
that  of  New  York  was  passed  in  Pennsylvania.  Mary^- 
land  passed  a  law  in  1900  and  California  one  in  1901. 
Laws  were  enacted  by  Illinois  and  Washington  in  1903 
and  by  New  Jersey  in  1904.  Other  states  followed  in 
1905,  1906,  1907,  1908  and  1909,  until  in  all  twenty-one 
laws  have  been  passed.  The  essential  ideas  embodied  in 
these  acts  of  legislation  are  the  establishment  of  condi- 
tions under  which  the  certificate  or  degree  of  C.  P.  A. 
(Certified  Public  Accountant)  may  be  granted,  and  the 
making  of  provision  for  the  enforcement  of  standards 
through  examinations  offered  by  a  board  of  examiners 
which  is  presumably  responsive  to  the  best  professional 
opinion  on  the  subject.  No  action  has  been  taken  by  the 
Federal  Government  with  reference  to  the  recognition  of 
certified  public  accountants  and  nothing  has  been  done 
in  connection  with  public  regulation  of  corporation  ac- 
counts that  specifically  calls  for  the  recognition  of  certi- 
fied public  accountants  as  such.  It  has  been  desired  by 
some  that,  in  its  inspection  of  the  accounts  of  corpora- 
tions, the  Federal  Government  should  accept  a  certificate 
on  certain  points  rendered  by  a  properly  qualified  public 
accountant  but  thus  far  nothing  whatever  has  been  ac- 
complished in  that  direction. 

Professional  Control. 

Professional  control  of  the  standards  and  methods  of 
the  accountancy  profession  is  proceeding  along  much  the 
same  lines  as  have  been  followed  in  other  occupations. 
Associations  of  accountants  have  been  organized,  conspic- 

report,  annually,- their  receipts  and  expenses  under  the  provisions  of  this  act 
to  the  state  comptroller  and  pay  the  balance  of  receipts  over  expenditures  to 
the  state  treasurer.  The  regents  may  revoke  any  such  certificates  for  sufficient 
cause  after  written  notice  to  the  holder  thereof  and  a  hearing  thereon. 

Section  3.  The  regents  may,  in  their  discretion,  waive  the  examination 
of  any  person  possessing  the  qualifications  mentioned  in  section  one  who 
shall  have  been,  for  more  than  one  year  before  the  passage  of  this  act,  prac- 
ticing in  this  state  on  his  own  account,  as  a  public  accountant,  and  who  shall 
apply  m  writing  for  such  certificate  within  one  year  after  the  passage  of  this  act.j 

Section  4.     Any  violation  of  this  act  shall  be  a  misdemeanor. 

Section  5.    This  act  shall  take  effect  immediately. 


ACCOUNTANCY  EXAMINATIONS  213 

uously  the  American  Association  of  Public  Accountants, 
which  hold  regular  meetings  and  a  part  of  whose  duty  it 
is  directly  or  indirectly  to  pass  upon  the  standards  for 
admission  to  the  profession  and  the  practices  that  may 
be  followed  within  it.  In  this  as  in  other  professions,  the 
control  exerted  by  such  associations  has  been  unofficial 
purely  and  has  been  intended  to  exert  merely  a  wholesome 
influence  in  the  way  of  forming  public  opinion  and  estab- 
lishing standards  of  conduct.  This  movement  is  being 
assisted  through  the  organization  of  courses  in  account- 
ing and  subjects  kindred  thereto  in  several  of  the  princi- 
pal universities  of  the  country.  In  these  it  is  sought  to 
give  training  which  will  not  only  fit  for  the  taking  of  C. 
P.  A.  examinations  but  will  also  equip  students  for  further 
work  along  new  lines  in  accounting  where  expert  qualifica- 
tions of  the  larger  sort  than  those  called  for  by  routine 
accountancy  are  demanded. 

Scope  of  Education. 

In  accountancy,  as  in  other  professions,  it  is  found  that 
the  examinations  which  are  required  of  those  who  de- 
sire to  obtain  a  certificate  authorizing  them  to  practice 
the  profession  are  usually  placed  at  a  minimum  by  the 
constituted  authorities;  that  is  to  say,  the  certificate  of 
C.  P.  A.  represents  about  the  smallest  amount  of  informa- 
tion that  is  actually  requisite  to  the  practice  of  the  pro- 
fession. This  does  not  mean  that  C.  P.  A.  examinations 
are  *^easy" — quite  the  reverse — but  that  their  scope  is  lim- 
ited to  those  subjects  which  are  undoubtedly  indispensable, 
or  practically  so,  to  the  accountant's  work.  The  question 
may  fairly  be  raised  then  how  far  actual  education  can  be 
directed  toward  the  fitting  of  men  for  the  passing  of  ac- 
countancy examinations,  how  far  more  general  education 
is  actually  needed  by  the  would-be  accountant,  and  in  what 
directions  this  kind  of  education  should  be  secured.    In 


214  ACCOUNTANCY  EXAMINATIONS 

considering  these  questions,  a  beginning  may  be  made  with 
the  scope  of  the  C.  P.  A.  examination. 

C.  P.  A.  Examinations. 

Some  states  limit  the  examination  itself  to  commercial 
law  and  general  accounting  with  fairly  large  liberty  to 
the  board  of  examiners  to  arrange  the  different  papers 
on  different  branches  of  the  subject  as  they  see  fit.  Other 
laws  provide  for  examinations  in  the  theory  of  accounts, 
in  auditing,  in  practical  accounting,  and  in  commercial  law. 
Here  the  greatest  difficulty  to  be  met  by  the  student  at 
the  outset  perhaps  lies  in  discriminating  between  the  theory 
of  accounts  and  the  practical  accounting.  At  another  point 
in  this  volume  (see  pp.  211,  ff.)  have  been  reproduced  the 
questions  set  over  a  period  of  years  in  the  ISTew  York  state 
examinations  with  reference  to  the  theory  of  accounts.  A 
reading  of  these  questions  will  show  the  nature  of  the  in- 
formation which  has  been  grouped  under  that  head  by 
the  New  York  examiners  who  may  be  taken  as  fairly  rep- 
resentative of  the  profession.  It  is  seen  that  these  ques- 
tions relate  entirely  to  the  principles  of  accounting,  that 
is  to  say,  to  the  question  how  certain  operations  should  be 
performed  or  problems  should  be  solved  and  not  to  the 
actual  solving  of  difficult  questions  of  technique.  In  order 
to  get  the  information  needed  for  this  particular  phase  of 
an  accountancy  examination  the  student  may  consult,  in 
addition  to  the  works  in  this  series,  several  excellent  works 
which  have  been  listed  elsewhere  in  this  volume  (see 
page  210).  Among  these  as  suitable  for  the  beginner  may 
be  mentioned  Grierson's  Bookkeeping  for  Commercial 
Classes,  Grierson's  Advanced  Bookkeeping,  Dicksee's 
Bookkeeping  for  Accountant  Students,  Dicksee's  Advanced 
Accounting,  Lisle 's  Accounting,  Sprague's  Philosophy  of 
Accounts,  and  for  a  few  special  points  Keister's  Corpora- 
tion Accounting.  For  current  discussions  of  new  prob- 
lems and  for  information  designed  to  keep  the  student 


ACCOUNTANCY  EXAMINATIONS  215 

abreast  of  the  times  in  accountancy  recourse  may  be  had 
to  The  Accountant  published  weekly  in  London  (Moor- 
gate  Street)  and  the  Journal  of  Accountancy  published 
in  New  York  (32  Waverly  Place).  From  these  sources 
sufficient  information  can  be  obtained  by  the  student  who 
is  working  independently,  to  fit  him  to  pass  the  account- 
ancy examinations.  Of  course,  if  he  is  so  situated  as  to 
be  able  to  attend  courses  in  accountancy,  such  as  are  given 
by  some  of  our  imiversities  located  in  large  cities,  he  will 
profit  very  largely  by  attending  lectures  and  classes,  even 
though  nothing  is  added  to  his  general  stock  of  informa- 
tion, but  only  a  training  in  methods  of  work  and  in  the 
point  of  view  to  be  adopted  with  reference  to  the  study 
of  accountancy. 

Practical  Accounting. 

Practical  accounting  is  differentiated  from  the  'theory 
of  accounts  in  that  the  papers  consist  of  problems  presum- 
ably drawn  from  actual  experience.  The  candidate  is 
called  upon  to  give  an  adequate  solution  of  the  problem 
by  showing  how  such  a  question  would  be  dealt  with  in 
practice  and  sketching  usually  the  various  entries  that  are 
necessitated  by  the  terms  of  the  problem.  Obviously  only 
two  suggestions  can  be  made  with  reference  to  this  por- 
tion of  the  examination:  (1)  The  candidate  should  have  as 
large  a  practical  experience  as  possible  in  accounting;  the 
more  varied  it  is  the  better  training  it  provides  for  the 
quick  working  out  of  the  practical  questions;  (2)  in  lieu 
of  practical  experience,  which  not  all  perhaps  can  have 
secured  prior  to  taking  the  examination,  the  candidate 
should  familiarize  himself  with  as  many  questions  as  pos- 
sible from  those  that  have  actually  been  set  in  the  past 
by  accountancy  boards  and  particularly  by  the  board  of 
examiners  in  his  own.  state.  Difficulty  often  arises  in  this 
part  of  the  accountancy  examination  from  the  fact  that 
the  time  allowed  is  very  short,    so   that   the    candidates, 


216  ACCOUNTANCY  EXAMINATIONS 

although  they  might  successfully  work  out  the  problems 
if  they  had  time,  fail  by  reason  of  the  fact  that  they  cannot 
answer  enough  questions  in  a  sufficiently  short  time  to 
make  a  passing  grade.  It  is  said  that  "more  candidates 
fail  in  practical  accounting  than  in  any  of  the  other  sub- 
jects." Probably  an  important  part  of  ther  preparation 
for  the  examination  will  be  found  in  familiarizing  one's 
self  with  a  great  number  of  actual  practical  problems 
stated  in  general  terms,  so  that  in  the  examination  room 
the  candidate  may  be  able  to  assign  any  particular  state 
of  facts  or  problem  that  may  be  set  before  him  to  a  given 
class  of  general  problems  or  conditions  previously  formed 
in  his  own  mind  through  the  study  of  typical  instances. 

Auditing. 

The  examination  on  auditing  is  likely  to  be  somewhat 
of  a  combination  of  questions  of  theory  and  practice.  This 
involves  the  difficulties  of  both  classes  of  questions  and  it 
has  been  said  that,  to  pass  a  good  examination  in  audit- 
ing, experience  is  almost  absolutely  necessary;  this  expe- 
rience to  be  had  of  course  in  practical  auditing,  which 
means  substantially  in  an  auditor's  office.  Some  states 
require  that  a  candidate  shall  have  served  a  given  number 
of  months  in  such  an  office  before  becoming  a  candidate 
for  examination  but  this  is  not  a  universal  requirement. 
Experience  shows,  however,  that  where  such  practical 
training  has  not  been  had  candidates  may  pass  very  satis- 
factory examinations  in  auditing  provided  they  have  sur- 
veyed the  ground  in  sufficient  detail  beforehand.  The  dif- 
ficulty comes  from  the  fact  that,  as  auditing  is  essentially 
a  practical  matter,  the  student  who  seeks  to  pass  the  ex- 
amination is  obliged  to  substitute  the  results  of  his  reading 
for  practical  experience.  True,  in  some  cases,  examination 
papers  do  not  deal  specifically  vdth  auditing  as  such  but 
in  many  instances  the  questions  set  are  those  which,  it 
might  be  expected,  would  come  under  the  head  of  theory 


ACCOUNTANCY  EXAMINATIONS  217 

of  accounts.  Nevertheless,  most  auditing  examinations 
contain  specific  questions  with  reference  to  the  process 
to  be  pursued  in  actually  auditing  the  accounts  of  a  firm 
or  corporation. 

By  way  of  preparation  for  such  an  examination  the 
student,  in  addition  to  the  work  he  has  devoted  to  the  the- 
ory of  accounts  as  such,  may  well  cover  the  subject  of 
auditing,  using  the  reliable  volume  on  this  subject  in  the 
present  series.  For  additional  reading,  Dicksee's  Audit- 
ing is  recommended.  To  this,  however,  should  be  added 
studies  of  the  way  in  which  the  business  of  actual  con- 
cerns is  in  practice  audited.  Information  on  this  topic 
can  be  obtained  by  securing  the  instructions,  blanks,  etc., 
employed  in  examining  the  accounts  and  books  of  various 
classes  of  concerns  which  are  subject  to  periodical  exam- 
ination. One  of  the  best  examples  of  this  sort  of  work  will 
probably  be  found  in  the  National  Bank  Examination  Sys- 
tem, data  about  which  have  already  been  given  in  this  vol- 
ume (see  page  172).  By  carefully  studying  the  process  of 
auditing  and  examining  the  books  of  a  concern  as  it  is  fol- 
lowed out  in  some  important  system  of  this  sort,  a  substi- 
tute for  practical  experience  may  be  had  which  will  serve 
the  purpose  in  the  examination  room. 

Mr.  William  A.  Chase  gives  the  following  as  an  example 
of  a  representative  examination  on  auditing: 

What  are  the  nature  and  principles  of  an  audit? 

Illustrate  the  bearing  of  the  term  ^depreciation'  upon 
accounts  representing  investments  in  stocks  and  shares, 
buildings,  leases,  plant  and  machinery,  and  profit  and  loss. 

In  auditing  the  accounts  of  the  first  financial  year  of 
a  corporation  which  Avas  formed  to  acquire  an  established 
business,  what  documents,  books,  etc.,  would  you  require 
to  have  produced  for  your  inspection? 

It  is  frequently  alleged  that  dividends  have  been  paid 
out  of  capital.  Explain  this  statement  and  point  out  in 
what  ways  a  dividend  can  be  so  paid. 


218  ACCOUNTANCY  EXAMINATIONS 

Are  there,  in  your  opinion,  any  circumstances  which 
would  justify  the  addition  to  actual  cost  of  any  anticipated 
profit,  in  the  case  of  partially  manufactured  goods,  or  of 
an  uncompleted  engineering  contract,  or  in  similar  cases'? 

In  your  examination,  as  auditor  of  securities  consisting 
of  bonds  to  bearer,  inscribed  stocks,  certificates  for  shares 
and  bills  receivable,  what  would  be  your  method  of  pro- 
cedure and  what  main  object  would  you  have  in  view? 

A  firm  expends  large  sums  upon  advertisements  in 
order  to  form  a  business.  Assuming  that  the  expenditure 
thereon  decreases  annually  until  in  the  seventh  year  it 
reaches  a  point  representing  a  normal  annual  cost  under 
this  head,  how  would  you  expect  the  amounts  to  be  treated 
in  each  year's  balance  sheet?  In  your  reply  let  $70,000.00 
be  the  expenditure  of  the  first  year,  and  decrease  $10,000.00 
annually. 

What  steps  would  you,  as  auditor,  take  to  see  that  prop- 
er provision  had  been  made  for  bad  and  doubtful  debts? 

(a)  In  the  case  of  a  private  firm. 

(b)  In  the  case  of  a  corporation. 

In  auditing  the  accounts  of  a  trading  firm  or  corpora- 
tion, state  the  steps  you  would  take  to  verify  the  cash  book. 

If  you  were  asked  to  make  an  examination  of  a  firm's 
books  for  the  purpose  of  giving  a  certificate  of  profite  with 
a  view  to  its  conversion  into  a  corporation,  how  would  you 
make  your  examination,  and  what  are  the  chief  points  to 
which  you  would  direct  your  attention?  \ 

Commercial  Law. 

Accountancy  examinations  usually  include  a  paper  on 
commercial  law  and  this  has  raised  the  question  whether 
a  man  before  becoming  an  accountant  ought  not  really  to 
be  legally  trained.  A  law  education  is  by  some  held  to  be 
very  desirable  as  a  part  of  an  accountant's  equipment 
while  others  are  inclined  to  question  the  usefulness  of  the 
law  examination  as  ordinarily  given.  Many  papers  on  com- 


ACCOUNTANCY  EXAMINATIONS  219 

mercial  law  are  undoubtedly  little  more  than  enough  to 
indicate  a  mere  smattering  on  the  part  of  the  person  who 
passes  the  examination.  For  this  reason  a  systematic 
course  in  a  resident  or  good  correspondence  school  of  law 
is  by  many  insisted  upon  as  a  really  necessary  part  of  an 
accountant's  equipment,  since  such  knowledge  of  law  as 
he  possesses  will  probably  stand  him  in  good  stead  in  unex- 
pected ways  in  connection  with  the  accounting  work  that 
may  fall  to  him  to  do.  Undoubtedly  in  accountancy,  as  in 
other  professions,  a  broad  thorough  knowledge  of  all  sub- 
jects that  are  even  collaterally  connected  with  the  princi- 
pal subject  to  which  the  candidate  is  devoting  himself  will 
be  of  value,  but  on  the  other  hand  this  idea  might  easily 
be  carried  so  far  as  to  render  it  practically  impossible  in 
operation.  As  a  matter  of  fact,  the  accountancy  examina- 
tions, in  so  far  as  they  relate  to  commercial  law,  do  not 
presuppose  a  professional  law  training  but  merely  such 
ideas  on  law  as  are  directly  and  intimately  relevant  to 
accounting  ideas.  The  student  should  be  familiar,  for  ex- 
ample, with  the  National  Bank  Act  and  the  National 
Bankruptcy  Act,  as  well  as  with  local  statutes  relating 
specifically  to  banking,  insurance,  partnership,  corpora- 
tions, commercial  paper,  estates,  etc.,  and  other  matters 
of  like  character.  "American  Law  and  Procedure,"  in  14 
volumes,  edited  for  the  LaSalle  Extension  University  by 
Dean  Hall,  of  the  University  of  Chicago,  and  by  James  De- 
Witt  Andrews,  of  the  New  York  Bar,  is  the  simplest  com- 
plete, non-technical  treatment  of  the  whole  field.  For  the 
student  who  finds  it  necessary  to  get  the  utmost  possible 
information  with  the  smallest  amount  of  work  the  volume 
on  Commercial  Law  by  Hirschl,  and  published  in  this  series 
by  the  LaSalle  Extension  University,  is  recommended. 

Mr.  Chase  gives  the  following  as  an  example  of  an  ordi- 
nary accountancy  examination  on  commercial  law: 

What  do  you  know  about  the  doctrine  of  ultra  vires  as 
applied  to  officers  of  a  corporation^    Give  an  example. 


220  ACCOUNTANCY  EXAMINATIONS 

How  far  is  the  fact  tliat  a  person  shares  in  the  profits 
of  a  business  conclusive  evidence  that  he  is  a  partner? 
What  further  evidence,  if  any,  is  necessarj^  to  determine 
whether  he  is  a  partner  or  not  ? 

What  do  you  understand  by  the  phrase,  **A  seal  is  said 
to  import  a  consideration"?  A  says  to  X,  '*I  want  to  take 
your  watch  to  pieces,  but  I  will  put  the  pieces  together 
again."  X  consents,  but  A,  after  taking  it  to  pieces,  re- 
fuses to  put  it  together  again,  and  contends  that  there  was 
no  consideration  for  his  promise  to  do  so.  Is  he  right? 
Give  your  reasons. 

In  what  cases  will  a  purchaser  of  goods  from  a  seller 

(a)  who  is  not  the  owner  of  them, 

(b)  who  has  only  a  voidable  title  to  them,  himself 
get  a  good  title  ? 

State  the  various  ways  in  which  an  agent's  authority 
may  be  determined? 

When  and  how  does  the  failure  to  present  a  bill  of  ex- 
change for  payment  affect  the  rights  of  the  holder? 

How  far  is  the  right  of  stoppage  in  transitu  affected  by 
the  transfer  of  bills  of  lading?  Would  the  fact  that  the 
transferee  had  not  paid  the  consignee,  or  that  the  transfer 
w^as  by  way  of  security  for  an  advance,  affect  your  answer? 

Can  a  corporation,  if  it  chooses  to  do  so,  issue  preferred 
stock? 

Is  it  necessary  to  copjnnght  trade-marks  and  trade- 
brands  to  protect  the  owner  against  tHeir  use  by  compet- 
itors? 

In  your  state  what  does  the  law  provide  as  to  the  pay- 
ment in  part,  or  in  full,  of  the  issue  of  capital  stock  by  a 
corporation? 

Knowledge  of  Mathematics. 

While  some  knowledge  at  least,  of  law  in  its  commer- 
cial aspects,  is  required  in  order  to  pass  the  accountancy 
examination  and  while  a  general  knowledge  of  law  is  by 


ACCOUNTANCY  EXAMINATIONS  221 

many  considered  desirable,  a  knowledge  of  mathematics  is 
by  others  strongly  recommended  as  a  valuable  part  of  an 
accountant's  equipment.  By  mathematics  as  the  term  is 
here  used  is,  of  course,  meant  the  higher  mathematics.  This 
is  by  some  urged  on  the  ground  that  it  tends  to  increase 
accuracy,  power  of  concentration,  and  ability  to  reason 
clearly  and  logically,  powers  which  it  is  alleged  are  more 
strongly  cultivated  by  the  study  of  mathematics  than  by 
any  other  study.  Whether  the  study  of  mathematics  is 
of  more  value  for  these  purposes  than  other  kinds  of  study 
is  a  question  which  need  not  be  discussed  here  but  it  is 
undoubtedly  true  that  in  some  branches  of  accountancy, 
particularly  in  those  dealing  with  actuarial  questions  and 
with  depreciation  in  some  of  its  aspects,  a  knowledge  of 
mathematics  is  serviceable.  There  is  however  no  present 
probability  that  knowledge  of  the  higher  mathematics 
will  be  demanded  in  the  near  future  as  a  part  of  account- 
tancy  requirements. 

Fairness  of  Examinations. 

The  question  of  the  degree  of  fairness  shown  in  carry- 
ing on  the  C  P.  A.  examinations  in  certain  states  is  one 
that  has  caused  considerable  discussion  in  the  past.  It 
has  been  charged  by  not  a  few  persons  that  the  examina- 
tions in  some  places  were  conducted  in  such  a  way  as  to 
eliminate  as  many  candidates  as  possible  and  this  charge 
has  been  particularly  pressed  in  New  York  where  at  times 
the  percentage  of  failure  has  been  very  large.  In  New 
York  about  two-thirds  of  all  applicants  were  excluded  dur- 
ing a  period  of  years,  while  in  one  year  only  9  per  cent  of 
the  candidates  examined  in  practical  accounting  were 
passed.  Usually  the  questions  are  ten  in  number  on  each 
topic  to  which  a  separate  paper  is  given,  and  the  time 
allotted  for  each  paper  is  three  hours.  It  has  frequently 
been  charged  that  the  papers  set  were  so  long  that  it  was 
impossible  to  write  the  answers  in  the  time  allowed,  no 


222  ACCOUNTANCY  EXAMINATIONS 

matter  how  well-equipped  the  candidate  miglit  be,  while 
in  some  instances  questions  had  been  obscure  and  there 
had  been  ambiguity  in  the  form  of  their  expression  due 
to  doubt  about  the  meaning  of  a  specific  word  or  clause. 
Occasionally  examiners  have  shown  a  disposition  to  bo 
technical  in  formulating  their  questions,  while  others  have 
been  biased  against  accountants  whose  ideas  differed  much 
from  their  own.  The  examiners  have  usually  been  ap- 
pointed for  short  terms  and  have  been  busy  men  so  that 
in  many  instances  they  have  not  acquired  the  experience 
as  examining  bodies  or  probably  devoted  the  time  to  their 
work  that  was  necessary  in  order  to  get  the  best  results. 
It  must  also  be  reluctantly  admitted  that  there  has  been 
a  disposition  on  the  part  of  some  accountants  to  desire 
to  keep  the  profession,  and  particularly  the  degree  of  C. 
P.  A.  which  goes  with  it,  as  close  a  monopoly  as  possible. 
This  has  been  for  the  selfish  reason  that  with  fewer  firms 
of  recognized  accountants  there  would  be  more  demand 
for  the  services  of  each,  while  it  would  be  easier  to  secure 
the  aid  of  staffs  of  men  who  needed  experience  in  an  ac- 
counting office  as  a  prerequisite  to  their  becoming  candi- 
dates for  the  C.  P.  A.  degree.  Attention  has  been  called 
to  these  undesirable  aspects  of  the  situation  by  various 
investigators  among  which  may  be  mentioned  representa- 
tives of  the  New  York  Journal  of  Commerce  and  Commer- 
cial Bulletin,  while  Ernest  S.  Suffern,  C.  P.  A.,  in  the  Jour- 
nal of  Accountancy*  calls  attention  to  some  of  the  points 
referred  to.  How  long  this  condition  of  affairs  will  be 
permitted  to  exist  as  undoubtedly  does  exist  in  many 
states,  may  be  mentioned,  but  there  is  reason  to  believe 
that  the  practice  will  gradually  decrease  as  its  prevalence 
has  done  more  to  prevent  the  adoption  of  C.  P.  A.  legisla- 
tion than  perhaps  any  other  influence.  The  profession  of 
accountancy  as  a  profession  is  still  insecure  in  the  United 
States  notwithstanding  the  dignified  position  it  has  secured 

*  March.  1910,  pp.  384,  fif. 


ACCOUNTANCY  EXAMINATIONS  223 

in  England,  Scotland  and  other  countries.  In  order  to 
put  it  on  a  permanently  recognized  professional  basis,  it 
must  of  course  accept  high  professional  standards  in  its 
own  attitude  toward  professional  questions  such  as  those 
relating  to  admission  to  the  occupation.  In  palliation  of 
the  indefensible  things  that  have  occasionally  been  done 
in  connection  with  examinations  in  some  states,  it  of  course 
is  claimed  that  there  has  been  a  large  number  of  ill-pre- 
pared candidates  in  the  field,  which  is  undoubtedly  true, 
while  it  is  further  alleged  that  these  candidates  have 
lacked  uniform  text-books  and  suitable  opportunities  for 
training  in  many  instances,  this  lack  of  uniformity  and 
want  of  a  common  training  being  itself  one  of  the  circum- 
stances which  have  prevented  the  giving  of  examinations 
in  a  uniform  and  standardized  way.  Doubtless  there  is 
some  basis  for  this  statement  as  applied  to  New  York, 
while  in  many  other  states,  it  is  the  general  consensus  of 
opinion;  the  criticisms  already  offered  with  respect  to  the 
methods  already  pursued  in  giving  accountancy  examina- 
tions have  not  the  same  basis  as  in  the  State  of  New  York 
itself. 

One  criticism  which  admittedly  holds  good  in  New 
York,  and  in  some  other  states  as  well,  is  based  on  the  de- 
lays and  irrelevant  obstacles  of  one  kind  or  another  that 
are  frequently  thrown  in  the  way  of  men  who  have  passed 
the  necessary  examination.  It  has  appeared  in  New  York, 
particularly,  that  even  in  some  cases  where  men  had  done 
all  that  was  necessary  in  order  to  get  their  C.  P.  A.  cer- 
tificates the  certificates  were  not  forthcoming,  owing  to 
technical  delays  attributed  in  some  cases  to  a  failure  on 
the  part  of  the  candidate  to  establish  his  possession  of 
necessary  preliminary  education  or  to  some  other  circum- 
stance of  which  the  applicant  undoubtedly  should  have 
been  informed  prior  to  the  date  when  he  had  supposed 
himself  eligible  for  his  degree.  In  other  cases  men  who 
iiave  asked  for  a  review  of  their  papers  have  been  denied 


224  ACCOUNTANCY  EXAMINATIONS 

the  rights  which  they  possessed  under  the  law  on  the 
ground  that  the  examiners  had  not  the  time  to  attend  to 
the  matter.  These  of  course  are  sporadic  cases  and  the 
instances  cited  have  been  drawn  chiefly  from  experience 
in  New  York.  While,  as  already  indicated,  there  are  simi- 
lar difficulties  in  other  states,  it  is  probable  that  nowhere 
else  is  there  so  much  to  be  complained  of. 

Advantage  of  General  Training. 

In  what  has  been  said  thus  far,  atjtention  has  principally 
been  given  to  the  actual  requirements  of  the  law  with  ref- 
erence to  accountancy  examinations.  These  requirements 
must,  of  course,  be  lived  up  to  by  those  who  desire  to  get 
legal  and  official  recognition  as  Certified  Public  Account- 
ants. Behind  all  such  purely  legal  requirements,  however, 
is  the  fact  that  the  most  effective  work  in  the  profession 
of  accountancy  can  be  done  by  those  who  have  the  best 
general  training  in  the  scientific  study  of  modem  business 
and  commerce.  A  general  knowledge  of  economics  is  un- 
doubtedly of  large  value  to  the  student,  the  more  valuable 
in  proportion  as  the  study  of  economics  has  been  directed 
along  practical  lines  rather  than  to  the  purely  theoretical 
side  of  the  subject.  Of  course  it  is  also  true  that  thorough 
educational  training  in  other  directions  will  serve  the  same 
purpose  in  equipping  a  man  for  accountancy  that  it  does 
in  equipping  him  for  other  occupations.  Thorough  pre- 
liminary general  education  obtained  before  the  candidate 
thinks  seriously  of  devoting  himself  to  a  technical  occupa- 
tion is  highly  desirable  in  this  as  in  other  lines  of  work. 

Preliminary  Education. 

Preliminary  education  is  now  usually  limited  in  the  re- 
quirements to  the  equivalent  of  a  high  school  course  of 
standard  grade  and  while  this  may  be  advanced  in  some 
states  before  very  long  it  is  not  likely  that  the  level  thus 
set  will  be  raised  very  materially  or  generally  for  some 
time  to  come. 


EXAMINATIONS  ON  THE  THEORY  OF  ACCOUNTS. 

I. 

1.  State  the  essential  principles  of  double  enti^-  book- 
keeping and  show  wherein  it  differs  from  single  entry 
bookkeeping. 

2.  Describe  the  following  and  show  wherein  they  differ: 
(a)  trial  balance,  (b)  balance  sheet,  (c)  statement 
of  affairs,  (d)  realization  and  liquidation  account. 

3.  In  devising  a  system  of  accounts  for  a  business  what 
are  the  main  subjects  for  consideration,  and  in  what 
order  should  they  have  attention? 

4.  Describe  the  following  and  show  wherein  they  differ: 
(a)  revenue  account,  (b)  trading  account,  (c)  profit 
and  loss  account,  (d)  deficiency  account. 

5.  State  the  purposes  for  which  series  of  perpendicular 
columns  are  employed  in  books  of  original  entry  and 
how  these  purposes  may  be  accomplished  relative  to 
the  following  conditions :  (a)  several  ledgers  compre- 
hended in  one  system  of  accounts,  (b)  several  depart- 
ments comprehended  in  one  business,  (c)  several  ac- 
counts comprehended  in  income  and  expenditure. 

6.  Describe  the  following  and  show  wherein  they  differ: 
(a)  statement  of  income  and  expenditures,  (b)  state- 
ment of  receipts  and  payments. 

7.  Describe  a  method  of  keeping  accounts  so  that  the 
aggregate  sums  due  from  customers  and  due  to  cred- 
itors can  be  known  without  preparing  a  schedule  of 
the  accounts  of  such  customers  and  creditors,  and  so 
that  an  independent  balance  of  the  ledger,  containing 
only  the  real,  nominal,  special  and  controlling  ac- 
counts, exclusive  of  the  individual  accounts  of  custo- 

B.VIII— 16  225 


226  EXAMINATION  QUESTIONS 

mers  and  of  trade  creditors,  may  be  taken. 

8.  Define  and  differentiate:    (a)    capital  and  revenue, 

(b)  capital  receipts  and  revenue  receipts,  (c)  capital 
expenditure  and  revenue  expenditure. 

9.  How  may  the  accounts  in  a  trial  balance  be  best  ar- 
ranged to  facilitate  the  preparation  of  a  business  and 
financial  statement? 

10.  Define  and  differentiate:  (a)  fixed  assets  and  cash 
assets,  (b)  fixed  liability  and  floating  indebtedness, 

(c)  fixed  charges  and  operating  expenses. 

11.  Describe  the  following  kinds  of  accounts:  (a)  per- 
sonal, (b)  impersonal,  (c)  real,  (d)  nominal,  (e)  cur- 
rent, (f)  summary. 

12.  Describe  the  process  and  state  some  of  the  purposes 
of  analyzing  a  ledger. 

13.  Describe  the  nature  of  the  following  accounts:  (a) 
sinking  fund,  (b)  reserve  fund,  (c)  redemption  fund, 

(d)  depreciation  fund,  (e)  contingent  fund,  (f)  in- 
vestment fund. 

14.  Define  the  following:  (a)  stock,  (b)  capital,  (c)  sur- 
plus, (d)  deficiency,  (e)  capital  stock,  (f)  preferred 
stock,  (g)  common  stock,  (h)  share  capital,  (i)  loan 
capital. 

15.  Describe  the  nature  of  the  following  accounts:  (a) 
merchandise,  (b)  construction,  (c)  consignment,  (d) 
joint,  (e)  subscription,  (f)  expense,  (g)  maintenance, 
(h)  venture,  (i)  suspense,  (j)  dividend. 

n. 

1.  Describe  the  principal  books  of  account  of  some  con- 
cern with  which  you  are  familiar,  and  show  the  rela- 
tion and  connection  of  these  books. 

2.  What  various  meanings  may  an  entry  in  a  ledger 
account  have,  on  (a)  the  debit  side?  (b)  On  the  credit 

^oi    side? 

3.  Show  the  advantages  and  the  disadvantages  of  the 


EXAMINATION  QUESTIONS  227 

column  system  for  books  of  original  entry. 

4.  Describe  the  process  of  closing  the  ledger  of  a  mer- 
cantile firai. 

5.  In  what  ways  may  bad  or  doubtful  debts  be  disposed 
of  at  the  close  of  a  fiscal  period? 

6.  What  are  the  functions  of  the  cash  book?  Describe 
the  peculiarities  of  one  or  more  cash  books  with  which 
you  are  familiar. 

7.  In  what  order  should  the  several  items  in  a  balance 
sheet  be  placed?    Give  reasons  for  your  answer. 

8.  Describe  a  bill  book  and  show  its  relation  to  (a)  the 
bills  receivable  account;  (b)  the  bills  payable  account. 

9.  How  should  one  proceed  to  detect  an  error  in  a  trial 
balance? 

10.  State  various  ways  of  treating  the  bank  balance  in 
connection  with  cash  on  hand. 

11.  Describe  the  merchandise  account  as  ordinarily  kept. 
Show  how  it  may  be  subdivided  and  suggest  improve- 
ments. 

12.  How  may  a  set  of  books  be  changed  from  single  entry 
to  double  entry? 

13.  Describe  various  uses  of  the  journal. 

14.  What  are  the  functions  of  a  real  estate  account? 
What  entries  may  it  properly  have  on  each  side? 

15.  Describe  the  stock  ledger  (shares  ledger)  of  a  corpora- 
tion and  show  how  it  is  kept. 

III. 

1.  What  are  the  main  features  of  difference  between  a 
trial  balance  taken  out  at  the  end  of  a  fiscal  year 
before  the  books  of  a  business  are  closed,  and  one 
taken  out  immediately  after  the  books  are  closed? 

2.  What  is  meant  by  (a)  capital?  (b)  Working  capital? 
Why  is  capital  always  shown  on  a  balance  sheet  as 
a  liability? 

3.  Formulate  journal  entries  to  express  fully  each  of  the 


228  EXAMINATION  QUESTIONS 

following  transactions:  (a)  a  sale  of  goods  for  a  note 
bearing  interest,  (b)  the  discounting  of  tbe  above- 
mentioned  note  at  a  bank,  (c)  the  annulling  of  a  per- 
sonal account  as  uncollectable,  (d)  the  adjusting  of 
an  interest  account  for  interest  earned  but  not  yet 
collected. 

4.  Under  what  circumstances  is  a  patent  regarded  as  an 
asset?  After  a  patent  has  been  valued,  should  such 
value  be  considered  as  permanent?  Give  reasons  for 
your  answer. 

5.  In  the  opening  of  a  ledger,  what  principle  should  be 
followed  as  to  the  order  of  arrangement  of  the  ac- 
counts?   Show  the  advantages  of  different  plans. 

6.  Describe  a  set  of  books  for  a  commission  merchant. 
Show  the  relation  of  each  book  to  the  other  books  of 
the  set. 

7.  State  what  is  meant  by  a  cost  sheet,  showing  its  ad- 
vantages and  how  it  is  made  up.  Give  a  form  of  cost 
sheet  for  some  manufacturing  business  with  which 
you  are  familiar. 

8.  What  is  meant  by  the  good-will  of  a  business  ?  Under 
what  circumstances  does  it  become  important  to  de- 
termine the  value  of  the  good- will  of  a  business?        I 

9.  Mention  five  classes  of  ledgers  and  describe  the  pe- 
culiar features  of  each  class.  ' 

10.  Describe  the  following,  and  state  the  distinguishing 
feature  of  each:  (a)  income  account,  (b)  surplus  ac- 
count, (c)  suspense  account,  (d)  reserve  fund. 

11.  Define  (a)  funded  debt,  (b)  floating  indebtedness, 
(c)  fixed  charges.  May  interest  on  floating  debt  prop- 
erly be  considered  a  fixed  charge  ? 

12.  State  cases  in  which  leases  have  a  value  that  should 
appear  in  the  accounts.  How  should  provision  be 
made  in  such  cases  for  the  falling  out  of  such  value 
at  the  expiration  of  the  leases? 


EXAMINATION  QUESTIONS  229 

13.  In  case  of  discrepancy  in  a  trial  balance,  how  may 
the  accountant  ascertain  which  side  is  erroneous? 

14.  How  may  the  gross  profit  or  loss  on  merchandise  be 
ascertained? 

15.  Describe  the  profit  and  loss  account.  Show  how  this 
account  is  made  up  and  from  what  accounts  it  is  made. 
What  does  the  balance  of  the  profit  and  loss  account 
represent,  and  how  should  such  balance  be  finally 
treated  ? 

IV. 

1.  Describe  fully  each  of  the  following  accounts,  show- 
ing what  entries  may  be  made  on  each  side  and  what 
disposition  should  be  made  of  the  balance:  (a)  cash 
account,  (b)  interest  account,  (c)  merchandise  ac- 
count, (d)  suspense  account,  (e)  real  estate  account. 

2.  Describe  the  following  securities  and  show  the  essen- 
tial features  of  each:  (a)  common  stock,  (b)  pre- 
ferred stock,  (c)  income  bonds,  (d)  debenture  bonds, 
(e)  mortgage  bonds. 

3.  Describe  the  process  of  taking  a  trial  balance.  State 
the  purposes  of  the  balance  and  show  its  relations 
to  the  balance  sheet. 

4.  Give  a  rule  averaging  the  maturity  of  the  balance 
of  an  account  containing  items  of  various  dates  on 
each  side. 

5.  State  in  the  form  of  journal  entries  the  following 
transactions:  (a)  a  note  of  a  customer  returned  with 
protest  charges  from  the  bank  where  it  had  been  left 

'  for  collection,  (b)  the  setting  aside  for  wear  and  tear 
of  a  portion  of  the  value  of  machinery,  (c)  the  adjust- 
ment of  interest  accrued  but  not  yet  payable  on  a 
mortgage,  (d)  accommodation  paper  indorsed  by  the 
firm  when  coupon  bonds  are  received  as  security. 

6.  In  case  of  bonds  purchased  at  a  premium  or  at  a  dis- 
count, to  be  held  till  maturity,  state  how  the  price 


230  EXAMINATION  QUESTIONS 

should  be  disposed  of  on  the  books  at  purchase,  at 
maturity  and  at  any  intervening  time. 

7.  Formulate,  in  an  imaginary  case,  the  journal  entry 
or  entries  for  the  conversion  of  a  partnership  into  a 
joint  stock  company  with  the  same  resources  and  lia- 
bilities. ? 

8.  Describe  a  voucher  record  for  the  expenditures  of  a 
corporation.  .  . 

'  9.  What  is  meant  by  good- will  ?  What  kind  of  property 
is  good- will?  May  the  good- will  of  a  partnership  be 
sold?  ,       ,  i 

10.  What  names  are  given  to  accounts  that  represent  the 
excess  of  assets  over  liabilities?  Differentiate  these 
names  in  their  application  to  various  kinds  of  busi- 
ness. 

11.  What  is  the  proper  course  of  procedure  in  taking 
charge  of  the  bookkeeping  of  a  firm  that  has  either 
no  books  of  account  or  very  imperfect  ones? 

12.  Describe  fully  a  system  by  which  occasional  small 
sales  made  on  credit  to  persons  not  regular  customers 
may  be  recorded  without  opening  a  separate  account 
with  each  purchaser. 

13.  Describe  the  most  complicated  form  of  cash  book 
with  which  you  are  acquainted,  showing  its  functions, 
the  sources  from  which  its  materials  are  derived  and 
where  its  results  are  carried. 

14.  Describe  fully  the  method  of  keeping  a  bills  receiv- 
able account,  and  state  the  connection  of  the  account 
with  the  bill  book. 

15.  As  the  bookkeeper  of  a  firm  that  had  no  articles  of 
co-partnership,  what  would  be  your  duty  on  learning 
of  the  death  of  a  partner? 

V. 

1.  Define  debit,  credit,  debtor,  creditor.  State  the  gen- 
eral law  growing  out  of  the  relationship  of  debtor 


EXAMINATION  QUESTIONS  231 

and  creditor  that  governs  double  entry  bookkeeping. 
What  is  the  result  of  a  debit  entry?   Of  a  credit  entry? 

2.  Mention  the  different  classes  into  which  accounts  are 
usually  divided.  Give  the  names  of  the  principal  ac- 
counts of  each  class.  Which  class  or  classes  of  ac- 
counts close  into  loss  and  gain  account?  Mention  the 
principal  accounts  common  to  mercantile  bookkeep- 
ing and  state  the  purposes  of  each. 

3.  Define  assets,  liabilities.  What  are  fixed  assets,  quick 
assets?  In  making  up  a  general  statement  of  assets 
and  liabilities,  what  groups  of  accounts  constitute 
assets  and  what  constitute  liabilities?  State  how  to 
treat,  on  closing  the  books,  assets  and  liabilities  ac- 
crued but  not  actually  due  (such  as  interest  receiv- 
able and  payable,  taxes,  insurance,  commissions,  sal- 
aries, rents). 

4.  Describe  the  different  methods  of  determining  the 
loss  or  gain  of  a  business.  How  is  the  loss  or  gain 
of  a  business  determined  from  books  kept  by  single 
entry?  State  the  usual  mode  of  procedure  when  the 
books  are  kept  by  double  entry.  ■ 

5.  State  the  purpose  of  (a)  consignment  account,  (b) 
shipment  or  adventure  account,  (c)  adventure  joint 
account,  (d)  merchandise  company  account.  De- 
scribe how  each  should  be  opened,  conducted  and 
closed. 

6.  Describe  the  entries  necessary  to  open  a  set  of  double 
entry  books.  In  what  respect  is  the  double  entry  sys- 
tem preferable  to  the  single  entry  system? 

7.  Describe  the  process  of  changing  single  entry  books 
to  double  entry.  What  additional  accounts  are  re- 
quired? Is  it  necessary  to  disturb  any  accounts  al- 
ready opened  in  the  ledger,  or  to  keep  such  accounts 
differently  after  the  change? 

8.  Describe  in  detail  the  manner  of  closing  a  double 
entry  ledger.    How  should  the  results  of  the  business 


232  EXAMINATION  QUESTIONS 

be  started?  Why  is  property  unsold  credited  to  the 
account  to  which  it  belongs  before  closing?  How 
should  worthless  and  doubtful  debts  be  treated  in 
closing? 
9.  State  the  entries  necessary  to  open  a  set  of  corpora- 
tion books  so  that  the  assets  may  appear  properly  on 
the  ledger.  What  books  are  necessary  in  corporation 
accounting  that  are  not  necessary  in  mercantile  ac- 
counting? What  does  the  capital  account  show? 
Define  preferred  stock,  common  stock,  watered  stock. 

10.  State  the  object  of  each  of  the  following:  (a)  plant 
account,  (b)  capital  account,  (c)  surplus  or  reserve 
fund  account,  (d)  redemption  fund  account,  (e)  de- 
preciation account. 

11.  What  should  be  done  regarding  the  books  on  the  ad- 
mission of  a  new  partner  into  a  firm?  What  entry 
should  be  made  when  cash  is  invested  for  a  certain 
share  in  the  gains  and  losses?  What  entry  should 
be  made  when  a  specified  amount  is  paid  to  the  old 
members  for  a  certain  share  in  the  gains  and  losses? 

12.  What  is  understood  by  cost  or  factory  bookkeeping? 
What  is  shown  by  the  cost  books?  What  are  the 
principal  items  entering  into  the  cost  of  manufactured 
products  ? 

13.  What  is  meant  by  the  voucher  system  of  bookkeep- 
ing?   Describe  the  voucher  record  book. 

14.  How  should  executors'  and  administrators'  accounts 
be  stated  for  the  purpose  of  filing  in  court?  What 
does  the  summary  of  accounts  usually  include  ?  What 
are  assets  of  the  estate?  When  are  dividends,  inter- 
est and  rents  to  be  treated  as  principal?  Define  an 
intermediate  account.  What  is  a  final  account  ?  With 
what  does  the  executor  charge  himself?  For  what 
does  he  take  credit? 

15.  What  is  the  duty  of  the  assignee's  accountant  in  the 
case  of  an  assignment?  ^  How  is  the  inventory  stated? 


EXAMINATION  QUESTIONS  233 

What  are  included  in  the  schedules?  How  is  the 
assignee's  account  stated  for  submission  to  the  court? 
What  does  the  summary  of  account  usually  include"? 
With  what  does  the  assignee  charge  himself?  For 
what  does  he  take  credit? 

yi. 

1.  state  and  explain  the  two  principal  purposes  for 
which  accounts  are  kept. 

2.  What  important  features  of  a  business  are  shown  by 
double  entry  bookkeeping  that  single  entry  books  can 
not  show?    Explain  clearly. 

3.  Describe  the  ordinary  merchandise  account  and  state 
its  purpose.  Does  it  fully  accomplish  the  purpose 
desired?    Give  reasons  for  your  answer. 

4.  Describe  a  voucher  record  and  the  process  of  conduct- 
ing a  vouchers  payable  system.  State  fully  the  ad- 
vantage of  this  system. 

5.  Eecommend,  with  all  necessary  explanations,  a  set  of 
books  peculiarly  adapted  to  the  use  of  a  firm  that 
deals  exclusively  in  butter,  cheese  and  eggs,  at  whole- 
sale, retail  and  on  commission,  and  has  three  branches 
in  the  same  city,  the  books  kept  at  the  main  store. 

6.  Define  the  following  terms  as  applied  to  accounts: 
personal,  real,  nominal,  resource,  liability.  Men- 
tion two  real  and  three  nominal  accounts. 

7.  Describe  the  nature  of  the  following  accounts: 
consignment,  trading,  suspense,  construction,  sub- 
scription. 

8.  Formulate  and  explain  a  rule  for  determining  wheth- 
er an  account  should  be  debited  or  credited  in  any 
given  transaction.  Explain  the  application  of  the 
principle. 

9.  Describe  a  safe  and  easy  system  of  keeping  the  ac- 
count of  goods  returned,  (a)  as  buyer;  (b)  as  seller. 

10.     State  explicitly  and  fully  the  function  of  the  profit 


234  EXAMINATION  QUESTIONS 

and  loss  account.  Distinguish  between  the  function 
of  the  profit  and  loss  accoimt  and  that  of  the  balance 
sheet. 

11.  Some  proprietors  keep  a  private  ledger  of  their  busi- 
ness, to  which  bookkeepers  and  clerks  have  no  access. 
Explain  the  purpose  of  such  a  book,  and  show  what 
accoimts  it  usually  contains  and  how  it  is  made  to 
agree  with  the  general  ledger. 

12.  State  the  theory  and  purpose  of  each  of  the  follow- 
ing, and  show  wherein  they  differ:  (a)  reserve  fund, 
(b)  sinking  fund. 

13.  State  the  general  theory  of  the  balance  sheet.  On 
what  theory  does  the  English  form  of  balance  sheet 
differ  from  the  continental  and  American  form? 
Give  an  argument  either  for  or  against  the  English 
form. 

14.  Define  permanent  assets,  floating  assets.  Show  how 
each  should  be  treated  in  ascertaining  the  standing 
of  a  business  at  any  specified  time.  State  the  theory 
of  each  step  in  the  process. 

15.  Describe  two  forms  of  sales  ledger  and  the  process 
of  entering  the  sales  in  each.  Explain  the  advantage 
of  each  form. 

VII. 

1.  What  is  meant  by  double  entry  and  how  does  it  differ 
essentially  from  single  entry?  Show  the  advantages 
of  recording  every  business  transaction  in  two  or 
more  different  accounts. 

2.  State  what  is  indicated  by  each  of  the  following  ledger 
accounts,  (a)  when  the  account  shows  a  debit  bal- 
ance, (b)  when  the  account  shows  a  credit  balance, 
loss  and  gain,  merchandise,  customer's  ledger,  pur- 
chase ledger,  Chicago  branch  or  agenc}^,  insurance, 
rent,  interest,  commission.    Explain  fully. 

3.  Describe  a  private  ledger.  Describe  the  process  of 
opening  a  private  ledger  for  a  mercantile  firm.    What 


EXAMINATION  QUESTIONS  235 

relation  would  the  private  ledger  bear  to  the  general 
trial  balance? 

4.  Define  auditing,  accounting,  bookkeeping,  and  show 
the  relation  of  each  to  the  others. 

5.  You  are  required  to  suggest  a  method  of  bookkeep- 
ing and  to  undertake  the  annual  balancing  of  the 
books  of  a  large  wholesale  or  jobbing  establishment. 
What  general  methods  in  the  bookkeeping  would  you 
recommend,  and  what  plan  would  you  adopt  to  expe- 
dite your  work? 

6.  Describe  a  sinking  fund.  How  should  the  account  of 
such  a  fund  be  conducted  in  the  case  of  a  manufac- 
turing corporation  that  bonds  its  works  for  $100,000, 
payable  in  twenty  years,  and  wishes  to  accumulate 
during  that  period  the  sum  necessary  to  retire  the 
bonds  at  maturity? 

7.  What  is  a  controlling  account?  Give  an  illustration 
of  the  use  of  such  an  account. 

8.  Show  what  is  meant  by  the  following  terms:  Closing 
the  books,  balancing  the  books,  making  out  a  state- 
ment, preparing  a  balance  sheet,  taking  off  a  trial 
balance. 

9.  Describe  a  means  for  the  protection  of  a  manufac- 
turing company  in  the  purchase  of  necessary  mate- 
rials and  supplies  and  in  the  payment  for  such  ma- 
terials and  supplies. 

10.  State  the  process  of  making  a  trial  balance  of  a  single 
entry  ledger.  How  may  the  loss  or  gain  be  deter- 
mined from  books  kept  by  single  entry? 

11.  A  mercantile  house  draws  on  its  customers  at  sight, 
depositing  its  drafts  in  bank.  Occasionally  a  draft 
is  returned  dishonored.  What  entry  should  be  made 
when  a  draft  is  drawn,  and  what  counter-entry  should 
be  made  when  the  draft  is  returned  dishonored? 

12.  Describe  a  plan  for  handling  invoices   of  materials 


236  EXAMINATION  QUESTIONS 

purchased  for  the  use  of  a  factory,  payments  for  which 
are  to  be  made  at  the  best  discount  date. 

13.  Describe  an  approved  system  of  recording  and  vouch- 
ing petty  cash  transactions. 

14.  Give  the  iniling  of  a  stock  or  shares  ledger  for  a  corpo- 
ration. Show  how  this  book  is  kept,  and  indicate  its 
relation  to  the  general  books  of  account. 

15.  Illustrate  a  columnar  cash  book,  a  columnar  journal, 
and  a  columnar  sales  book.  What  general  require- 
ments should  be  observed  in  designing  such  books? 
Give  an  estimate  of  the  utility  of  the  columnar  plan. 

VIII. 

1.  State  one  general  rule  that  will  embrace  all  the  prin- 
ciples governing  double  entry  bookkeeping.  Define 
journalizing,  in  its  broadest  sense. 

2.  What  is  the  result  of  a  debit  entry  ?  Of  a  credit  entry? 
Illustrate  in  the  case  of  an  account  of  each  of  the 
following  classes:  (a)  personal,  (b)  real,  (c)  nominal. 

3.  State  the  characteristic  distinctions  between  single 
entry  bookkeeping  and  double  entry  bookkeeping. 
What  are  the  advantages  of  double  entry  over  single 
entry? 

4.  In  double  entry  bookkeeping,  why  are  the  debits  on 
the  left  and  credits  on  the  right? 

5.  Define  the  following  accounting  and  business  terms: 
Floating  capital,  fixed  capital,  quick  assets,  floating 
liabilities,  nominal  accounts,  passive  assets,  passive 
liabilities. 

6.  In  making  up  a  business  statement  or  a  balance  sheet, 
why  are  the  assets  placed  as  debits  and  the  liabilities 
as  credits?    Are  there  any  exceptions  to  this  rule? 

7.  Describe  the  entries  necessary  to  open  a  set  of  double 
entry  books  for  a  firm  just  starting  in  business. 

8.  In  closing  the  ledger  accounts  of  an  ordinary  busi- 


EXAMINATION  QUESTIONS  237 

ness  for  the  purpose  of  a  general  exhibit  of  affairs, 
what  order  should  be  observed? 
9.  Define  and  differentiate:  reserve  fund,  sinking  fund, 
depreciation,  surplus.  Classify  the  foregoing  as  as- 
sets or  liabilities  and  give  reasons  in  each  case.  Ex- 
plain the  meaning  of  an  item  in  suspense. 

10.  What  is  understood  by  the  term  net  profit?  State 
the  final  disposition  of  net  profit  in  the  books  of  a 
partnership;  of  a  corporation. 

11.  What  is  a  stock  (or  shares)  ledger?  Explain  the 
nature  of  its  records  and  describe  the  manner  in  which 
they  are  made.  What  relation  does  this  book  bear  to 
the  general  books  of  the  corporation? 

12.  Describe  and  illustrate  at  least  three  forms  of  ledgers 
adapted  to  customers'  accounts,  and  state  the  form 
you  prefer  for  some  specific  class  of  accounts. 

13.  What  plan  would  you  suggest  for  recording  in  the 
books  of  a  large  mercantile  firm  its  contingent  lia- 
bilities incurred  by  indorsements  on  bills  receivable? 

14.  What  distinction  would  you  make  in  an  ordinary  set 
of  books,  as  to  debits  to  the  merchandise  account; 
incidental  expenses  of  the  business;  losses  such  as  bad 
debts,  destruction  of  property,  etc.? 

15.  Give  a  rule  for  averaging  an  account  not  yet  due, 
for  the  purpose  of  settling  by  note. 

IX. 

1.  Into  what  general  classes  should  ledger  accounts  be 
divided?  State  the  distinguishing  feature  of  each 
class.    Mention  one  account  belonging  to  each  class. 

2.  State  a  comprehensive  general  rule  for  journalizing. 
Write  in  your  journal  the  entries  of  the  following 
transactions  and  explain  the  application  of  the  rule 
to  each  debit  and  credit:  You  receive  from  A.  Tru- 
man, administrator  of  an  estate  of  which  you  are  a  leg- 
atee, full  titles  to  property  as  follows:  warehouse  on 


238  EXAMINATION  QUESTIONS 

Bond  St.  valued  at  $175,000,  mortgaged  to  Ironclad 
Trust  Co.  for  $18,000;  suburban  residence,  valued  at 
$8,000;  100  shares  Tesla  Electric  Co.,  par  value  $100 
a  share.  Three  days  later  you  convey  the  residence 
as  a  gift  to  your  daughter. 

3.  Wliat  books  of  a  mercantile  finn  should  be  treated  as 
books  of  original  entry  and  be  posted  direct  to  the 
ledger?  Give  an  example  of  an  entry  that  should 
necessarily  be  made  in  the  journal. 

4.  State  the  different  steps  in  the  process  of  closing  the 
ledger  at  the  end  of  a  fiscal  period  and  give  the  rea- 
son for  each  step. 

5.  Explain  the  uses  and  relations  of  the  petty  cash  book 
to  the  principal  cash  book  for  a  jobbing  house  and 
make  five  illustrative  entries. 

6.  What  is  the  purpose  of  a  trading  account,  and  what 
general  result  should  it  show?  In  closing  the  ledger 
what  disposition  should  be  made  of  the  balance  of 
the  trading  account? 

7.  Explain  the  theory  of  good- will.  On  what  basis  should 
good- will  be  valued?  Is  good- will  a  fixed  or  a  float- 
ing asset?    Why? 

8.  Give  a  rule  for  adjusting  partners'  accounts  (a)  when 
the  gains  or  losses  are  to  be  divided  in  proportion 
to  each  partner's  investment  and  the  time  it  remains 
in  use;  (b)  when  the  proportion  of  gain  or  loss  is 
fixed  and  interest  is  calculated  on  excess  or  deficit 
of  capital. 

9.  What  books  besides  such  as  are  used  by  individuals 
or  firms  are  necessary  for  recording  the  transactions 
of  an  incorporated  company?  State  briefly  the  use 
of  each  book  mentioned. 

10.  How  should  inventories  be  treated  in  closing  the 
ledger  at  the  end  of  a  fiscal  period?  Is  the  common 
practice  of  adding  the  inventory  of  goods  on  hand  to 


EXAMINATION  QUESTIONS  239 

the  credit  side  of  the  merchandise  account  theoret- 
ically correct?    Explain. 

11.  Mention  four  items  of  information  in  addition  to 
those  usually  shown  in  the  books  of  a  mercantile  busi- 
ness which  should  appear  in  a  set  of  books  for  keep- 
ing the  accounts  of  a  factory.  Give  reasons  for  your 
answer. 

12.  What  class  of  expenditures  should  be  treated  as  assets 
at  the  close  of  a  fiscal  period? 

13.  Define  the  following  items  as  used  in  factory  account- 
ing: cost  of  production,  prime  cost,  general  charges, 
maintenance,  stores,  stock,  stock  debit  note,  store- 
keeper, writing  off. 

14.  What  is  meant  by  the  surplus,  or  surplus  fund,  of  a 
stock  company?  How  is  this  fimd  formed?  What 
is  its  purpose? 

15.  Describe  a  method  of  keeping  the  accounts  of  an  ex- 
ecutor and  state  what  books  are  necessary  for  the 
purpose. 

X. 

1.  Explain  the  theory  of  double  entry  bookkeeping,  and 
state  the  principal  advantages  of  the  double  entry 
system. 

2.  Into  how  many  classes  are  ledger  accounts  usually 
divided?  Mention  two  of  the  principal  accounts  of 
each  class,  and  state  the  purpose  of  each. 

3.  Define  current  assets,  current  liabilities.  Give  two 
examples  of  each. 

4.  Define  capital,  nominal  capital,  subscribed  capital, 
paid-up  capital,  good-will. 

5.  Define  the  following  terms:  balance  sheet,  reserves', 
items  in  suspense,  surplus,  impairment. 

6.  Describe  the  merchandise  account  and  its  use.  State 
how  it  should  be  used  in  (a)  a  jobbing  or  wholesale 
grocery  business,  (b)  a  department  store  such  as  that 


240  EXAMINATION  QUESTIONS 

of  Wanamaker  or  of  Siegel-Cooper  Co.,  (c)  a  manu- 
facturing firm  making  agricultural  implements. 

7.  Describe  tlie  process  of  changing  a  set  of  books  from 
single  to  double  entry.    Draft  an  example. 

8.  What  is  the  purpose  of  a  private  ledger?  Wliat  ac- 
counts are  usually  kept  in  the  private  ledger? 

9.  What  difference,  if  any,  should  be  made  between  the 
accounts  of  a  fiinn  and  the  accounts  of  a  corporation 
in  the  same  line  of  trade  and  doing  about  the  same 
amount  of  business?    Explain. 

10.  In  preparing  accounts  for  a  manufacturing  company, 
on  what  principle  should  expenses  be  divided  as  be- 
tween the  manufacturing  account  and  profit  and  loss? 
Give  examples. 

11.  In  designing  a  set  of  accounts  for  a  business,  how 
might  provision  be  made  for  a  constant  showing  of 
the  aggregate  sum  owing  by  customers  and  the  aggre- 
gate sum  owing  to  creditors,  without  the  necessity  of 
preparing  a  schedule  of  the  accounts  of  such  cus- 
tomers and  creditors? 

12.  In  making  up  the  cost  accounts  on  goods  produced 
by  a  factory,  what  items  of  expenditure  are  to  be  con- 
sidered? How  should  these  be  combined  to  show  the 
actual  cost  of  any  specified  product? 

13.  Draft  a  form  of  cash  book  to  be  used  where  all  re- 
ceipts are  deposited  in  bank  and  all  payments  are 
made  by  check.  Illustrate  the  use  of  this  book  by 
three  or  more  entries. 

14.  What  is  meant  by  a  consignment  account?  How 
should  a  consignment  account  be  stated  in  a  balance 
sheet? 

15.  From  what  accounts  is  a  profit  and  loss  account  pre- 
pared?   In  what  way  is  its  accuracy  proved? 

XI. 

1.    Robinson  &  Co.,  wholesale  dealers  in  notions,  whose 


EXAMINATION  QUESTIONS  241 

books  have  not  been  kept  by  double  entry,  wish  to 
improve  their  system  of  bookkeeping.  Write  a  brief 
report  advocating  double  entry,  setting  forth  the  su- 
periority of  that  method  generally,  and  showing  by 
specific  references  to  the  mode  of  bookkeeping  em- 
ployed by  them,  the  advantages  that  will  accrue  from 
the  change. 

2.  Your  suggestions  (see  Question  1)  as  to  a  change  of 
method  having  been  approved  by  Robinson  &  Co.,  you 
have  been  instructed  to  make  the  change  at  the  close 
of  the  fiscal  year;  state  in  detail  how  you  would  pro- 
ceed from  start  to  point  of  proof. 

3.  By  analysis  the  debit  side  of  merchandise  account 
shows  purchases  $60,000,  returns  to  us  $4,000,  entries 
offsetting  errors  in  sales  extensions  $2,000,  trade  dis- 
counts to  customers  $13,500,  balance  profit  $27,000, 
the  credit  side  shows  sales  $90,000,  returns  by  us 
$5,000,  allowances  to  us  $1,500,  inventory  at  close  of 
year  $10,000.  Suggest  such  change  in  the  method  of 
recording  the  foregoing  statement  as  would  readily 
show  (a)  net  amount  of  pui'chases,  (b)  net  amount 
of  sales,  (c)  percentage  of  profit. 

4.  State  generally  how  the  books  of  a  firm  doing  a  manu- 
facturing business  would  differ  from  those  kept  by 
a  trading  concern  as  to  (a)  books  of  record;  (b)  ledger 
accounts. 

5.  What  differences  in  books  and  accounts  would  exist 
between  a  partnership  and  an  incorporated  company 
carrying  on  a  similar  business? 

6.  State  the  scope  and  value  of  the  trial  balance.  In 
case  of  failure  to  prove,  how  would  you  proceed  to 
locate  the  difference? 

7.  The  building  of  an  insurance  corporation  valued  at 
$500,000  is  mortgaged  for  $300,000.  The  rental  value 
of  the  portion  occupied  by  the  corporation  is  $3,500 
a  year,  and  there  are  sixty  other  tenants  in  the  build- 

'B.VIII— 15 


242  EXAMINATION  QUESTIONS 

ing.  Mention  such  accounts  as  should  be  kept  and 
state  the  class  of  transactions  to  be  recorded  in  each. 
In  what  manner  and  to  what  extent  would  the  build- 
ing enterprise  be  included  in  the  annual  financial 
statement  of  the  corporation? 

8.  Outline  a  statement  of  assets  and  liabilities  and  an 
annual  statement  of  operations  of  a  manufacturing 
corporation.  State  how  you  would  treat  each  of  the 
following  items:  (a)  interest  paid  in  advance  not  fully 
earned,  (b)  insurance  unexpired,  (c)  interest  accrued, 
(d)  outlay  of  labor  and  material  on  goods  not  fully 
manufactured,  (e)  material  to  be  delivered  to  com- 
plete contracts  up  in  full,  (f)  depreciation  of  plant, 
(g)  provision  for  future  losses  on  present  outstand- 
ings. 

9.  Describe  the  following  accounts  and  state  where  and 
how  they  are  employed:  surplus,  good- will,  treasury 
stock,  maintenance,  suspense,  dividend. 

10.  In  a  statement  of  a  railway  corporation,  what  is  meant 
by  fixed  charges,  funded  debt,  floating  indebtedness, 
maintenance  of  way,  maintenance  of  equipment? 

11.  What  is  the  best  way  of  recording  customers'  jiotes 
so  that  the  true  condition  of  each  account  may  be 
shown?  What  is  the  most  approved  way  of  treating 
the  note  receivable  account  (a)  in  the  ledger?  (b) 
In  a  statement  of  affairs? 

12.  Arrange  a  plan  for  keeping  a  private  ledger  with 
which  the  general  ledger  will  agree  and  yet  in  no  way 
reveal  the  contents  of  the  private  ledger.  What  mat- 
ters are  usually  recorded  in  the  private  ledger? 

13.  Suggest  one  or  more  plans  by  which  an  inventory 
may  be  corroborated  or  impeached. 

14.  Describe  several  economies  in  accounting  made  pos- 
sible by  the  introduction  of  special  columns  in  books 
of  original  entry. 

15.  State  the  full  procedure  leading  up  to  the  entry  of 


EXAMINATION  QUESTIONS  243 

the  following  transaction  in  the  shares  of  a  corpora- 
tion, the  par  value  of  which  is  $100:  April  5,  1901. 
James  Williamson  receives  certificate  No.  75  for  100 
shares  full  paid.  May  3,  1901.  James  Williamson 
requests  a  transfer  to  George  T.  Jenkins  of  30  of  his 
100  shares.  Outline  a  form  of  stockholders'  ledger 
and  properly  enter  the  above  items  therein. 

XII. 

1.  On  what  general  principles  is  double  entry  bookkeep- 
ing based?  State  briefly  a  general  formula  for  the 
correct  recording  of  business  transactions. 

2.  Two  persons  exchange  with  each  other  their  respective 
notes  for  $1,000  each;  what  would  be  presumably  the 
object  of  such  exchange?  What  are  the  risk  and  the 
limit  (in  amount)  of  risk  of  each  party  to  the  transac- 
tion?   How  should  such  a  transaction  be  recorded? 

3.  A  retail  book  store  agrees  to  deliver  certain  sets  of 
books  at  $20,  on  payment  of  $2  down,  the  purchaser 
agreeing  to  make  $3  pajrments  for  each  of  the  six 
months  next  following.  It  is  expected  that  sales  on 
this  plan  will  aggregate  several  hundred  sets.  Sug- 
gest a  method  of  keeping  the  accounts,  so  that  re- 
sults may  be  readily  shown. 

4.  Give  all  the  stages  in  closing  the  books  of  a  mercan- 
tile corporation  from  the  time  they  are  fully  posted 
to  the  completion  of  the  financial  statement. 

5.  Describe  several  methods  of  recording  discounts  on 
accounts  as  paid,  avoiding  misstatement  of  receipts 
and  disbursements.  State  the  advantages  or  disad- 
vantages of  the  methods  proposed. 

6.  Outline  an  entry  recording  bond  interest  due  but  not 
paid  at  time  of  making  the  entry.  Wliat  are  the  ad- 
vantages of  such  an  entry? 

7.  Mention  other  items  which  could  be  treated  in  a  way 


244  EXAMINATION  QUESTIONS 

similar  to  that  suggested  for  interest  in  question  6 
and  state  the  advantages  of  such  treatment. 

8.  Give  several  methods  of  keeping  the  records  of  petty 
accounts  with  infrequent  customers. 

9.  What  should  be  the  procedure  in  stating  the  value 
of  stock  on  hand  at  the  time  of  a  fire,  the  financial 
books  being  intact  and  showing  the  amount  of  an 
inventory  taken  four  months  previous  to  the  fire  ? 

10.  Give  cases  where  it  is  proper  to  include  in  a  state- 
ment of  assets  and  liabilities  certain  receipts  and  dis- 
bursements not  occurring  in  the  period  under  review. 

11.  On  what  are  the  accounts  of  an  executor  based  ?  In 
preparing  his  account,  with  what  does  the  executor 
charge  himself  and  for  what  does  he  claim  credit? 

12.  How  should  entries  be  made  of  notes  receivable  in 
the  account  of  a  customer  whose  credit  is  limited  to 
a  fixed  maximum,  so  that  his  account  will  show  at 
all  times  the  amount  for  which  his  order  may  be  ac- 
cepted? 

13.  How  should  entries  be  made  of  the  discount  at  the 
bank  of  notes  received  under  circumstances  outlined 
in  question  12?  What  entry  should  be  made  as  the 
notes  are  paid  at  maturity? 

14.  State  cases  where  the  condition  known  as  ^'diminish- 
ing assets"  is  likely  to  arise.  How  should  such  cases 
be  treated? 

15.  You  are  called  on  to  assume  the  duties  of  general  clerk 
and  bookkeeper  in  an  establishment  where  the  ac- 

•  counting  has  been  very  meager  and  primitive;  state 
the  steps  that  you  would  take  to  reform  existing  con- 
ditions. 


SECTION  B. 
ACCOUNTING  TERMINOLOGY* 

The  accounts  of  American  states  and  of  the  "city  cor- 
poration" of  the  larger  municipalities  are  readily  sepa- 
rable into  two  groups:  (1)  The  accounts  kept  by  the 
general  fiscal  officers,  such  as  those  called  treasurers,  aud- 
itors, or  comptrollers,  for  the  state  or  city  as  a  whole;  and 
(2)  those  kept  by  the  executive  officers  of  the  several  di- 
visions of  the  Government  for  their  departments,  bureaus, 
or  offices.  The  accounts  last  mentioned  differ  radically 
from  those  kept  by  the  fiscal  officers  first  referred  to,  and 
no  description  of  or  statement  concerning  accounts  belong- 
ing to  the  first  group  is  applicable  to  those  included  in  the 
second;  hence  in  any  discussion  of  governmental  accounts 
the  two  groups  should  be  carefully  differentiated,  and  state- 
ments concerning  governmental  accounts  should  specifical- 
ly set  forth  the  group  to  which  reference  is  made.  To 
facilitate  this  differentiation  accounts  kept  by  the  treas- 
urer, auditor,  or  comptroller  for  the  state  or  city  as  a  whole 
are  here  called  general  accounts,  and  those  kept  solely  for 
or  by  individual  departments,  bureaus,  or  offices  are  called 
departmental  accounts. 

Accounts  of  Proprietors  and  Trustees. — The  accounts 
ordinarily  used  in  private  business  at  the  present  time 
are  of  two  distinct  types,  according  to  the  nature  of  the 
business  for  which  they  are  devised  and  installed.  The 
most  common  type  is  that  employed  by  corporate  and  indi- 

*  From  Statistics  of  Cities,  U.  S.  Census  Office. 

345 


246  ACCOUNTING  TERMINOLOGY 

vidual  enterprises  whicli  are  conducted  primarily  for  profit 
or  gain,  and  whose  accounts  are  records  of  the  rights  or 
interests,  liabilities,  gains,  and  losses  of  the  proprietors; 
while  the  other  t3^pe  of  accounts  is  employed  by  corpora- 
tions and  individuals  engaged  in  administering  the  affairs 
of  others  and  not  of  themselves.  Accounts  of  the  first 
type  are  called  by  Mr.  Charles  E.  Sprague,  in  ^'The  Philos- 
ophy of  Accounts,"  proprietorship  accounts;  and  those  of 
the  second,  fiduciary  accounts.  The  business  of  many  indi- 
viduals and  corporations  includes  transactions  for  the  bene- 
fit of  the  proi^rietor  and  for  the  benefit  of  others.  In  such 
cases,  the  principal  accounts  are  always  proprietorship  ac- 
counts, while  the  others  are  in  reality  fiduciary  in  charac- 
ter. 

All  departmental  accounts  of  governments  are  fiduciary 
in  character  and  constitute  the  best  examples  of  fiduciary 
accounts  to  be  met  with  either  in  governmental  or  in  private 
business.  They  show  on  one  side  the  amounts  of  money 
or  credit  placed  at  the  disposal  of  the  department,  bureau, 
or  office,  and  on  the  other  (1)  the  expenditures  made;  (2) 
the  reservations  of  the  appropriations  for  contracts,  market 
orders,  or  other  purposes;  and  (3)  the  free  or  unencum- 
bered balances  of  the  appropriations. 

The  general  fiscal  officers  of  our  American  states  and 
municipalities  are  required  to  keep  fiduciary  accounts  with 
appropriations.  In  addition,  they  must  keep  accounts  vnth 
other  financial  data  relating  to  revenues,  the  receipt  and 
■pajjnent  of  cash,  public  properties,  and  indebtedness.  The 
general  accounts  of  most  cities  wdth  their  appropriations 
are  not  combined  with,  nor  even  closely  associated  with, 
the  accounts  last  mentioned,  although  in  the  accounting 
systems  of  a  few  cities  the  two  classes  of  accounts  are 
combined  under  appropriate  controlling  accounts.  The 
general  appropriation  accounts  of  the  cities  of  the  former 
class  are  duplicates  of  the  departmental  accounts,  and, 
like  them,  are  models  of  fiduciary  accounting.    Of  the  cities 


ACCOUNTINa  TERMINOLOGY  247 

which  combine  the  two  classes  of  accounts  the  greater 
number  employ  fiduciary  accounts  of  a  type  that  originated 
in  the  earlier  stages  of  governmental  business.  A  smaller 
number  employ  fiduciary  accounts  so  arranged  as  to  make 
them  of  greater  administrative  value,  and  a  few  are  install- 
ing proprietorship  accounts.  Experience  will  be  required 
to  determine  the  relative  administrative  value  of  the  dif- 
ferent systems  of  accounts  mentioned. 

Differences  in  General  Governmental  Accounts. — ^In 
addition  to  the  differences  above  mentioned,  the  general 
accounts  of  American  cities  vary  greatly  in  character,  in 
methods,  and  in  the  bookkeeping  devices  employed,  of 
which  but  few  are  to  any  extent  common  to  the  different 
cities,  and  fewer  still  are  universally  used  in  private  busi- 
ness. In  some  cities,  the  only  books  of  general  accounts 
are  those  of  the  treasurer;  in  others,  additional  general 
accounts  are  kept  by  the  comptroller  or  by  whatever  other 
officer  exercises  the  duties  of  a  comptroller  or  auditor.  In 
the  great  majority  of  the  cities  of  the  latter  class,  the  books 
of  the  comptroller  are  in  some  of  their  essentials  the  same 
as  those  of  the  treasurer,  and  include  accounts  with  the 
treasurer,  which  are  a  check  upon  his  transactions.  The 
accounts  of  both  officers  have  one  feature  in  common  with 
the  accounts  of  private  enterprises,  in  that  they  always 
record  the  flow  of  cash  into  and  out  from  the  treasury. 
Moreover,  they  record  this  information  by  methods  that 
are  primarily  devised  to  show  whether  any  of  the  money 
received  is  lost  or  is  applied  to  purposes  other  than  those 
contemplated  by  the  legislative  bodies  authorizing  its  col- 
lection and  expenditure. 

The  fundamental  differences  in  the  general  accounts  of 
American  cities  have  the  same  origin  as  the  correspond- 
ing differences  in  the  accounts  of  private  enterprises,  in 
that  they  arise  from  the  varying  uses  to  which  the  accounts 
are  applied  in  the  administration  of  business.  At  first 
governmental  as  well  as  private  accounts  were  largely 


248  ACCOUNTING  TERMINOLOGY 

records  of  debts — the  amounts  owed  to  a  government  or 
private  proprietor  and  the  amounts  owed  by  it  or  by  him. 
The  accounts  were  kept  for  the  administrative  purpose  of 
assisting  in  collecting  all  amounts  due  and  of  meeting  all 
obligations  when  the  same  matured.  A  step  forward  was 
taken  in  private  business  when  accounts  were  arranged, 
kept,  and  summarized  in  such  a  way  that  in  addition  to 
providing  the  information  already  obtained  from  the  earlier 
records  they  embodied  all  the  fundamental  requirements 
of  modern  accounting  for  proprietorship  by  disclosing  the 
condition  of  business  at  specified  times,  and  the  gains  and 
losses  for  specified  periods.  Similar  progress  was  made 
in  accounting  for  constitutional  governments  when  their 
general  financial  records  were  so  arranged  that,  in  addition 
to  recording  all  the  data  included  in  the  earlier  accounts, 
they  introduced  all  the  requisites  of  correct  fiduciary  ac- 
counting by  exhibiting  the  cash  and  other  resources  avail- 
able for  expenditure  at  any  given  time,  and  the  fidelity 
with  which  expenditures  have  been  made  in  conformity; 
with  the  terms  of  appropriation  acts. 

Modem  Administrative  Uses  of  Accounts. — ^Within  the 
last  fifty  years  accounting  has  become  in  most  countries 
a  distinct  profession,  and  accounts  are  now  applied  as  ad- 
ministrative aids  both  to  private  and  to  governmental  busi- 
ness in  ways  never  dreamed  of  by  former  generations.  The 
earlier  accounts,  to  which  attention  has  been  called,  have 
not  been  neglected  or  displaced,  but  have  assumed  their 
position  in  more  comprehensive  schemes  introduced  by  thei 
most  progressive  private  and  public  administrators. 

The  modem  innovations  in  accounts  are  those  which 
provide  for  the  classification  and  analysis  of  financial  data 
and  their  arrangement  in  statistical  forms  so  as  to  show, 
in  private  business,  when  and  how  money  is  gained  and 
when  and  how  it  is  lost;  and  to  disclose  and  measure  in 
governmental  business  the  relative  efficiency  and  economy 
of  every  branch  of  service.    In  private  business,  an  analy- 


ACCOUNTINa  TERMINOLOGY  249 

sis  of  revenue  is  made  in  order  to  determine  the  adequacy 
of  rates  for  various  services  and  commodities,  and  every 
factor  of  business  administration  is  brought  under  account- 
ing control  by  means  of  what  the  business  world  now  knows 
as  *^cost  accoimting."  It  is  by  such  methods  that  the  lead- 
ers in  modern  private  business  have  made  accounts  and 
accounting  of  supreme  administrative  assistance  in  avoid- 
ing bad  and  securing  good  financial  results.  Their  ac- 
counts are  the  ideal  ones  of  the  business  world,  and  demon- 
strate the  great  part  that  accounting  records  can  play  in 
securing  success  and  avoiding  failure.  In  like  manner,  a 
few  governmental  officials  have  introduced  general  and  de- 
partmental accounts  which  accomplish  for  nations,  states, 
and  municipalities  what  the  analytical  and  statistical  ac- 
counts above  described  accomplish  for  private  enterprises. 
Their  accounts  are  so  arranged  as  to  provide  adequate 
accounting  control  over  revenue,  to  aid  in  preventing  waste 
or  loss  thereof  in  collection,  and  to  apply  the  principles 
of  private  cost  accounting  for  the  purpose  of  testing  the 
efficiency  and  economy  of  all  branches  of  governmental 
service. 

In  passing,  it  should  be  said  that  only  a  limited  num- 
ber of  private  concerns  have  developed  and  applied  ac- 
counts of  the  largest  possible  administrative  value,  and 
in  like  manner  only  a  few  governments  and  governmental 
officials  have  shown  themselves  fully  awake  to  the  value 
of  accounts  as  aids  to  good  government.  Hence  there  are 
great  differences  in  the  administrative  uses  to  which  gov- 
ernmental accounts  are  applied,  and,  as  an  inevitable  re- 
sult, great  differences  in  the  economy  and  efficiency  of 
local  governments.  This  condition  will  continue  until,  with 
other  changes  and  reforms,  the  general  and  departmental 
accounts  of  all  cities  are  so  arranged  as  to  measure  and 
test  the  efficiency  of  governmental  administration,  as  well 
as  the  fiduciary  responsibility  or  accountability  of  muni- 
cipal officers.    To  attain  fully  the  results  here  mentioned, 


250  ACCOUNTINa  TERMINOLOGY 

the  accounts  of  different  governments  of  the  same  class — • 
as  those  of  states,  counties,  cities,  and  towns — must  be 
arranged  on  such  bases  as  will  readily  permit  the  experi- 
ence of  each  to  be  compared  with  that  of  all  the  others. 

New  Systems  of  American  Governmental  Accounts. — 
A  considerable  number  of  American  cities,  actuated  by  a 
desire  to  make  their  financial  records  of  as  much  admini- 
strative assistance  as  are  those  of  the  most  progressive 
private  enterprises,  have  within  the  last  ten  years  intro- 
duced new  systems  of  general  accounts.  The  great  major- 
ity of  these  systems  can  best  be  described  as  experimental 
or  tentative,  since  they  are  being  applied  to  a  field  hitherto 
undeveloped  by  accountants.  There  is  no  uniformity  in 
the  systems  thus  introduced,  and  their  value  must  be 
measured  by  standards  other  than  those  of  uniformity  and 
the  possibility  of  comparing  the  expenses  and  outlays  of 
one  city  with  those  of  others.  The  experience  of  the  sev- 
eral cities  introducing  these  new  accounts  has,  however, 
on  the  whole,  been  fruitful  of  much  good,  and  out  of  it  no 
doubt  will  soon  be  evolved  systems  of  accounts  which  will 
give  to  governmental  officials  and  the  public  interested  in 
governmental  affairs  the  same  aid  that  the  most  successful 
business  man  secures  from  the  accounts  of  his  private 
business. 

The  general  accounts  thus  far  introduced  may  be  said 
to  be  of  two  distinct  types:  One  in  which  the  principal  or 
controlling  accounts,  in  addition  to  those  with  appropria- 
tions, are  those  with  cash  receipts  and  payments,  here 
spoken  of  as  accounts  based  on  cash  transactions;  and  the 
other,  in  which  they  are  accounts  with  amounts  accruing, 
as  revenue  or  otherwise,  to  the  benefit  of  the  city,  and 
with  the  accruing  expenditures  of  the  city,  here  referred 
to  as  accounts  based  on  accruals.  Accounts  of  the  former 
type  are  the  more  numerous.  That  fact,  and  the  further 
fact  that  the  older  forms  of  general  accounts,  still  in  use 
by  the  majority  of  cities,  are  of  the  same  type,  compels 


ACCOUNTINa  TERMINOLOGY  251 

the  Bureau  of  the  Census  to  arrange  its  statistics  upon 
the  basis  of  cash  receipts  and  payments. 

Comparable  Statistics,  How  Secured. — A  limited  num- 
ber of  cities  employing  the  older  forms  of  general  accounts, 
and  some  of  those  which  have  installed  improved  accounts 
of  the  type  first  mentioned  above — that  is,  accounts  based 
on  cash  transactions — prepare  exhibits  of  receipts  and  pay- 
ments in  such  a  manner  as  to  permit  comparisons  of  their 
costs  of  government  with  those  of  other  cities.  These  cities 
make  use  of  accounting  for  the  purpose  of  measuring  the 
efficiency  and  economy  of  administration  to  a  larger  ex- 
tent than  do  any  others.  The  financial  statistics  contained 
in  this  report  are  arranged  on  a  basis  which,  in  its  essen- 
tials, is  identical  with  that  employed  by  such  cities.  So 
far  as  these  statistics  realize  the  object  for  which  they 
are  prepared— the  object  set  forth  in  the  opening  para- 
graph of  this  introduction — they  become  of  assistance  in 
providing  accounting  tests  and  measures  of  the  efficiency 
of  the  administration  of  American  cities.  They  secure 
this  result  by  employing  accounting  devices  which  have 
been  introduced  by  many  municipal  fiscal  officers,  and 
which  consist  of  more  or  less  detailed  exhibits  of  receipts 
classified  by  source  and  of  warrant  payments  classified 
by  object.  The  classification  of  these  receipts  and  pay- 
ments into  real  or  actual,  and  nominal,  and  the  subdivision 
of  real  or  actual  receipts  or  payments  into  those  which  are 
and  those  which  are  not  available  for  meeting  the  costs 
of  government,  furnish  an  approximate  statement  of  the 
cost  of  operating  the  government  of  a  city  and  of  main- 
tainins:  its  several  functions;  and  if  all  the  bills  are  pre- 
sented  when  due  and  are  settled  at  once  by  the  issue  of 
warrants  to  be  paid  in  the  immediate  future,  such  a  classi- 
fication also  shows  the  relation  between  warrant  expendi- 
tures and  receipts. 

In  some  cities,  however,  large  numbers  of  warrants  or 
orders  having  the  authority  of  warrants,  are  paid  in  a  year 


252  ACCOUNTING  TERMINOLOaY 

subsequent  to  that  of  issue.  In  such  cities,  the  problem 
of  securing  from  the  books  of  the  treasurer  or  comptroller 
a  statement  of  the  cost  of  governmental  operation  and 
maintenance  and  of  expenditures  for  the  acquisition  or  con- 
struction of  permanent  properties  is  more  difficult.  Under 
such  conditions  the  classified  exhibit  of  the  treasurer's 
transactions  may  show  for  one  year  no  payments  for  the 
support  of  a  certain  function,  as  the  police  or  the  schools; 
while  for  the  next  year  it  may  show  disbursements  twice 
as  great  as  the  actual  cost  of  maintenance.  In  such  cities, 
the  aggregate  of  warrants  drawn  in  settlement  of  claims 
more  nearly  represents  the  cost  of  governmental  opera- 
tion and  maintenance  and  the  expenditures  for  permanent 
properties  than  does  the  aggregate  of  warrants  paid.  Yet 
a  tabulation  of  warrants  drawn,  combined  with  a  state- 
ment of  receipts,  does  not  furnish  a  complete  exhibit  of 
the  financial  transactions  of  a  given  year,  for  the  reason 
that  it  does  not  include  a  statement  of  the  warrants  or 
bills  payable  drawn  in  previous  years  but  liquidated  dur- 
ing the  current  year.  Hence,  from  the  standpoint  of  gov- 
ernmental accounting,  such  a  presentation  is  as  imperfect 
as  would  be  a  trader's  accounts  from  which  were  omitted 
outstanding  liabilities  for  merchandise  purchased.  To 
make  an  approximately  complete  exhibit,  for  a  given  fiscal 
year,  of  the  financial  transactions  of  cities  of  the  class  re- 
ferred to  in  this  paragraph,  not  only  must  the  comptrol- 
ler's record  of  warrants  drawn  during  the  year  be  pre- 
sented, but  also  the  treasurer's  statement  of  warrants  paid 
or  liquidated  during  the  year  must  differentiate  the 
amounts  paid  on  warrants  outstanding  at  the  beginning 
of  the  year  from  the  payments  made  on  those  drawn  during 
the  year.  On  this  basis  the  census  statistics  of  payments 
and  receipts  of  cities  are  compiled. 

Need  for  Uniformity  in  City  Accounts  and  Reports. — 
The  compilation  of  comparable  financial  statistics  of  cities 
is  at  the  present  time  attended  with  many  difiiculties  and 


ACCOUNTINa  TERMINOLOGY  253 

large  expense,  owing  to  differences  in  tlie  accounting  sys- 
tems and  methods  of  the  various  cities.  The  movement 
toward  the  uniform  classification  of  payments  and  receipts 
inaugurated  by  the  National  Municipal  League  gives  prom- 
ise of  a  reduction  of  these  difficulties  and  of  the  accompany- 
ing expense.  The  publication  of  the  census  reports  pre- 
senting the  financial  statistics  of  cities  has  given  the  move- 
ment a  great  impetus,  but  the  publication  of  these  reports 
will  not  alone  suffice  to  render  easy  of  attainment  compar- 
able financial  statistics  of  cities.  Before  that  end  can  be 
secured,  accountants  and  governmental  officials  must  reach 
some  common  understanding  as  to  the  fundamental  prin- 
ciples of  governmental  business  and  accounting,  as  ac- 
countants have  already  done  with  reference  to  the  funda- 
mental principles  of  commercial  accounting.  That  result 
can  be  secured  only  as  the  outcome  of  study  and  intelligent 
discussion  of  these  principles. 

Need  for  Correct  Methods  of  Conducting  Municipal 
Business. — Uniform  accounts  and  reports,  if  secured  as 
outlined  above,  will  be  of  great  assistance  in  compiling 
comparable  statistics  that  will  measure  the  relative  econ- 
omy and  efficiency  of  city  governments.  Such  accounts 
and  reports  alone  will  not,  however,  provide  the  data  for 
the  desired  statistics.  Before  such  statistics  can  be  com- 
piled, city  governments  must  not  only  establish  uniform 
accounts  and  make  uniform  reports,  but  they  must  also 
adopt  correct  and  uniform  methods  of  transacting  their 
financial  business.  Mention  has  been  made  of  the  differ- 
ence between  exhibits  of  governmental  expenditures  based 
respectively  upon  warrants  or  orders  issued  and  upon  war- 
rants or  orders  paid;  that  difference  is  material,  but  as  a 
factor  in  modifying  the  comparability  of  the  statistics 
obtained  for  the  different  cities  it  is  eliminated  by  the 
method  adopted  by  the  Bureau  of  the  Census  and  already 
described.  The  same  cannot  be  said  concerning  an  inac- 
curacy that  arises  in  the  census  exhibit  for  cities  with 


254  ACCOUNTING  TERMINOLOGY 

certain  faulty  business  methods,  and  with  no  proper  busi- 
ness system  of  auditing  bills  or  issuing  warrants.    In  some 
of  these  cities,  bills  are  in  reality  audited  by  approval  of 
the  city  council,  some  being  audited  promptly  when  pre- 
sented, while  others  are  not  approved  until  a  considerable 
length  of  time  thereafter.    Similar  variations  in  the  time 
elapsing  between  the  presentation  and  the  audit  of  claims 
occur  in  other  cities  having  auditors  or  comptrollers  with 
nominal  powers  of  adjusting  all  claims.    In  neither  case 
are  warrants  or  audited  bills  for  a  given  period  true  ex- 
hibits of  the  costs  of  government  for  that  period,  so  that 
W'hether  exhibits  of  governmental  expenditures  are  based 
upon  warrants  issued,  as  are  those  now  compiled  by  the 
Bureau  of  the  Census,  or  upon  audited  bills,  the  statistics 
for  such  cities  will  fail  to  be  comparable  with  those  for 
other  cities  which  have  adopted  correct  business  methods. 
This  condition  of  affairs  will  continue  until  cities  are  com- 
pelled by  state  law — if  they  will  not  do  so  by  their  own 
initiative — to  employ  business  methods  of  auditing  bills 
when  due,  and  to  pay  those  bills  promptly  by  the  issue  of 
warrants  on  the  treasury.     Such  an  improved  method  of 
conducting  the  finances  of  cities  would  accomplish  two  very 
important  results — it  would  render  possible  the  compila- 
tion of  statistics  which  would  measure  the  relative  effi- 
ciency and  economy  of  municipal  administration,  and  at 
the  same  time  eliminate  one  of  the  most  potent  single 
factors  in  governmental  graft  and  dishonesty. 

Need  for  a  Common  Terminology  in  Accounting. — ^The 
subjects  of  correct  and  uniform  accounting  and  of  improved 
business  methods  for  cities  and  their  industries,  and  for 
public  service  corporations  under  national  or  state  super- 
vision and  control,  are  of  great  popular  interest,  and  many 
accountants,  economists,  governmental  officials,  and  public 
w^riters  are  giving  them  earnest  thought.  The  average 
accountant  is,  however,  of  necessity,  devoting  most  of  his 
attention  to  improving  the  methods  of  accounting  and 


ACCOUNTINa  TERMINOLOGY  255 

business  administration  in  accordance  with  his  own  ideas; 
he  is  working  out  his  own  schemes  without  seeking  the 
co-operation  of  others.  The  result  is  that,  while  better 
accounting  and  more  efficient  business  methods  are  being 
introduced  both  in  publicly  and  privately  owned  enter- 
prises and  in  governmental  business  as  a  whole,  the  country 
is  not  securing  uniformity  as  rapidly  as  is  desirable. 

Uniformity  in  systems  of  accounting  must  be  based 
upon  a  common  language  of  accounts — that  is,  upon  the 
use  of  a  common  terminology.  To  aid  in  securing  that 
uniformity,  the  schedules  and  schemes  of  accounts  should 
be  accompanied  with  definitions  of  each  accounting  term 
employed,  and  the  reason  for  adopting  that  term,  where 
the  usage  of  the  commercial  world  and  governmental  world 
is  not  uniform.  The  publication  and  discussion  of  such 
definitions  and  explanations  will  open  the  way  for  the 
final  selection  of  those  terms  which  are  best  adapted  for 
securing  improved  and  uniform  governmental  accounts  and 
reports. 

Accounts. — Accounts  are  exhibits  of  financial  transac- 
tions with  individuals — natural,  corporate,  and  govern- 
mental— and  of  financial  data  relating  to  various  subjects, 
set  forth  by  counter  entries  called  debits  and  credits. 

Accounting. — Accounting  is  the  art  of  applying  accounts 
as  aids  in  the  administration  of  business,  or  the  science 
of  analyzing,  recording,  and  summarizing  data  relating 
to  business  in  such  a  way  as  to  disclose  its  condition  or 
state  at  any  given  time,  to  express  the  results  of  its  opera- 
tion for  any  given  period,  and  to  furnish  all  other  informa- 
tion that  such  analyzing,  recording,  and  summarizing  can 
provide  for  its  systematic  and  most  successful  adminis- 
tration. 

Attention  has  already  been  called  to  the  progressive 
development  of  this  science  and  the  application  of  its 
principles  in  the  fields  both  of  private  and  of  governmental 
business,  and  to  the  two  different  types  of  general  govern- 


256  ACCOUNTINa  TERMINOLOGY 

mental  accounts  employed  at  the  present  time  by  American 
cities.  In  general  accounts  of  the  type  most  frequently 
used  by  governments  in  the  United  States — accounts  based 
on  cash  transactions — the  principal  or  controlling  accounts 
supplemental  to  the  appropriation  accounts  are  those  sum- 
marizing the  receipts  and  payments  of  cash,  while  in 
general  accounts  of  the  other  type — accounts  based  on  ac- 
cruals— the  corresponding  controlling  accounts  are  those 
summarizing  amounts  accruing  for  the  benefit  of  the  Gov- 
ernment and  those  summarizing  the  accruing  expenditures 
of  the  Government.  Notwithstanding  this  difference,  the 
two  types  of  accounts,  if  they  are  to  be  of  equal  adminis- 
trative assistance,  must  record  and  summarize  substan- 
tially the  same  facts  and  deal  with  the  same  accounting 
entities.  Under  such  circumstances  uniformity  in  the  use 
of  accounting  words  and  phrases  will  contribute  much  to 
the  value  of  accounts  of  both  types,  and  render  the  ac- 
counts of  each  type  more  intelligible  to  those  employing 
accounts  of  the  other  type.  Attention  is  first  called  to  the 
financial  data  that  must  be  included  in  a  correct  and  com- 
plete summary  of  governmental  financial  conditions  and 
to  the  definitions  of  the  terms  commonly  employed  by  the 
Bureau  of  the  Census  in  speaking  of  those  data. 

Assets. — The  assets  of  an  individual  corporation  or 
government  are  the  properties  or  wealth — including  rights 
of  action,  franchises,  good- will,  and  other  rights  having  a 
money  value — in  its  possession  or  control  or  at  its  dis- 
posal. The  term  is  employed  with  the  significance  stated 
in  fiduciary  accounting  as  well  as  in  accounting  for  pro- 
prietorship. 

Economists,  in  speaking  of  wealth  used  for  productive 
purposes,  or  of  the  wealth  represented  by  the  assets  re- 
corded in  the  proprietorship  accounts  of  gainful  enter- 
prises, always  use  the  word  ** capital."  The  same  word 
is  sometimes  employed  as  an  accounting  term  in  referring 
to  the  wealth  last  mentioned,  but  should  never  be  used 


ACCOUNTING  TERMINOLOGY  257 

in  referring  to  the  wealth  in  the  control  or  custody  of  an 
individual,  corporation,  or  government  as  trustee. 

Classification  of  Assets. — In  accounts,  assets  are  always 
represented  by  debit  entries  and  balances.  Some  of  the 
debit  entries  and  balances  in  the  asset  accounts  of  corpora- 
tions and  governments  represent  wealth  actually  in  their 
possession  or  control,  or  at  their  disposal;  and  others  rep- 
resent the  claims  of  one  division  or  branch  of  the  business 
or  service  upon  another,  or  are  in  other  ways  offsets  to 
the  credit  balances  of  liability,  capital  stock,  surplus, 
revenue  accumulation,  or  other  accounts,  being  amounts 
recorded  in  so-called  asset  accounts  to  assist  in  securing 
accounting  control  over  governmental  appropriations  or  for 
other  purposes.  The  amounts  represented  by  the  first  class 
of  entries  are  here  called  actual  assets  to  distinguish  them 
from  those  represented  by  the  second  class,  which  are  here 
called  nominal  assets.  Nominal  assets  which  consist  of 
wealth  not  now  in  the  possession  or  control  or  at  the  dis- 
posal of  an  individual,  firm,  corporation,  or  government, 
but  which  under  certain  conditions  may  come  into  such 
-possession  or  control,  or  be  placed  at  such  disposal,  are 
generally  called  contingent  assets. 

When  classified  according  to  their  relation  to  the 
principal  purposes  of  the  business  in  which  they  are  used, 
the  actual  assets  of  private  enterprises,  governmental  de- 
partments, and  governments  are  given  the  specific  designa- 
tions of  current,  invested,  and  fixed  assets. 

The  current  assets  of  a  governmental  department, 
bureau,  or  office  are  the  amounts  of  money  which  by  the 
terms  of  appropriation  acts  or  ordinances  it  is  authorized 
to  expend,  while  the  current  assets  of  a  government  are 
the  resources  or  wealth  which  have  been  acquired  or  pro- 
vided for  meeting  the  cost  of  those  materials  and  services 
which  constitute  its  current  expenses,  interest,  outlays,  and 
investments,  and  for  meeting  all  other  claims  of  creditors 
and  trust  beneficiaries  that  mature  or  become  due  dur- 

B— VIII— 17 


258  ACCOUNTING  TERMINOLOGY 

ing  any  given  fiscal  period.  The  current  assets  of  govern- 
ment include  cash,  materials  and  supplies,  authorized  but 
uncollected  revenues,  prepayments,  advances,  and  accounts 
and  bills  receivable.  The  accounts  of  most  governments 
with  their  current  assets  include  considerable  amounts  of 
nominal  assets  in  the  form  of  uncollectible  revenues  not 
properly  written  off.  All  other  amounts  recorded  in  such 
accounts  representing  actual  wealth  in  their  possession  or 
control  constitute  their  *' current  assets." 

Invested  assets,  or  investments,  are  those  resources  or 
forms  of  wealth  which  have  been  acquired  and  are  held 
by  private  enterprises  and  by  governments  for  purposes 
other  than  those  for  which  they  were  organized  and  are 
maintained.  Among  the  many  purposes  for  which  invest- 
ments may  be  acquired  and  held  are  those  of  securing  an 
income  from  their  use,  of  deriving  gain  from  their  rise  in 
value,  of  avoiding  losses  that  otherwise  would  be  suffered, 
and  of  securing  other  business  advantages  that  may  seem 
possible  through  their  acquisition  and  possession.  The 
principal  nominal  invested  assets  recorded  in  American 
governmental  accounts  are  the  debt  obligations  of  the  Gov- 
ernment held  by  its  sinking  funds  and  other  funds  with 
investments.  All  investments  other  than  the  securities 
above  mentioned  are  ^'actual  investments"  or  ^'actual  in- 
vested assets." 

Funds  is  a  common  designation  of  the  invested  and 
current  assets  of  governments.  They  are  the  amounts  of 
money  or  other  forms  of  wealth  devoted  to  or  available 
for  specified  purposes.  Governmental  funds  are  of  three 
classes — general,  special,  and  trust. 

A  general  fund  is  one  that  is  not  specifically  limited 
as  to  the  source  from  which  its  stock  of  wealth  or  resources 
is  derived,  nor  as  to  the  object  for  which  that  stock  may 
be  disbursed.  It  is  a  fund  that  includes  money  or  other 
forms  of  wealth  which  is  derived  from  many  sources  and 
which  is  to  be  expended  for  many  objects. 


ACCOUNTINa  TERMINOLOGY  259 

A  special  fund  is  one  whose  assets  or  resources  are 
derived  from  a  specified  source  or  are  to  be  applied  to  a 
designated  object. 

A  trust  fund  in  private  business  and  accounts  is  a  fund 
the  legal  title  of  which  is  vested  in  a  trustee  who  holds  it 
subject  to  the  rights  of  others  to  enjoy  certain  benefits 
arising  therefrom.  In  governmental  business  and  accounts, 
where  all  funds  may  be  considered  as  "trust  funds,"  as 
above  defined,  a  trust  fund  is  a  "special  fund"  whose  as- 
sets consist  of  wealth  held  for  non-governmental  uses,  or 
wealth  obtained  by  donations  or  grants  for  specified  gov- 
ernmental uses. 

To  constitute  a  governmental  special  or  trust  fund,  the 
resources  or  assets  belonging  thereto  must  be  separated 
from  the  body  of  other  assets  or  resources,  and  accounts 
must  be  kept  showing  all  facts  relating  to  the  acquisition, 
present  status,  and  disposition  of  such  resources.  Govern- 
mental assets  separated  from  other  assets  and  held  for 
specified  purposes  in  such  manner  as  to  constitute  a  special 
or  trust  fund,  are  said  to  be  "reserved,"  and  are  therefore 
called  reserved  assets  or  asset  reserves,  and  the  funds  are 
frequently  spoken  of  as  "reserve  funds." 

Accounts  with  general,  special,  and  trust  funds  are 
properly  spoken  of  as  fund  accounts,  and  each  receives 
a  specific  designation  according  to  the  character  of  the 
fund  and  the  purposes  for  which  its  assets  are  reserved. 

Cash. — The  money  and  bank  credits  belonging  to  an 
enterprise  or  government  are  generally  spoken  of  as  cash. 
"Cash"  set  apart  in  trust  and  other  special  funds  for 
specified  purposes  is  here  spoken  of  as  trust  and  special 
cash,  or  reserved  cash.  All  other  cash  is  called  general 
fund  cash  or  general  cash. 

For  a  statement  as  to  the  nature  of  the  current  assets 
here  spoken  of  as  "authorized  but  uncollected  revenues," 
see  a  later  page  under  "revenues." 

Materials  and  supplies  is  the  general  designation  em- 


260  ACCOUNTINa  TERMINOLOaY 

ployed  by  accountants  for  all  tangible  things  in  the  posses- 
sion of  a  government  or  an  enterprise  which  have  been 
acquired  and  are  held  by  it  for  consumption  in  operation 
or  construction,  or  for  sale. 

Prepa>^nents  are  amounts  of  money,  or  money's  worth, 
which  have  been  expended  in  meeting  costs  which  are 
properly  chargeable  as  expenses  or  interest  of  the  future 
and  not  of  the  present  or  the  past. 

Advances  are  amounts  of  money,  or  money's  worth, 
placed  in  the  hands  of  fiscal  officers  or  agents  to  be  dis- 
bursed in  meeting  expenses,  outlays,  and  indebtedness,  or 
for  making  investments  in  the  future. 

Bills  receivable  are  amounts  of  money,  or  money's 
worth,  due  from  individuals,  corporations,  or  governments 
for  the  payment  of  which  formal  acknowledgments  in  writ- 
ing are  held,  while  accounts  receivable  are  similar  amounts 
due  for  which  no  such  acknowledgments  are  held,  and 
which  are  represented  principally  or  solely  by  entries  in 
current  accounting  records.  In  governmental  accounting, 
bills  and  accounts  receivable  should  be  carefully  dis- 
tinguished from  uncollected  revenues. 

Fixed  assets  are  those  resources  or  forms  of  wealth 
employed  in  the  accomplishment  of  the  principal  purposes 
of  private  enterprises  or  of  governments  which  have  an 
expectation  of  life  in  service  of  more  than  one  year.  The 
fixed  assets  of  governments  include  those  forms  of  wealth 
used  for  governmental  purposes  which  are  generally  called 
properties,  street  improvements,  and  sewers. 

Properties  is  the  designation  here  employed  by  the 
Bureau  of  the  Census  in  referring  to  land  used  for  gov- 
ernmental purposes  other  than  for  highways,  to  buildings 
and  other  more  or  less  permanent  structures  on  such  land, 
and  to  furniture,  tools,  apparatus,  and  other  equipment 
having  a  life  in  service  of  more  than  one  year,  other  than 
hand  tools  and  other  small  portable  tools  which  may  be 
lost  or  stolen  and  of  which  no  accounting  record  is  kept. 


ACCOUNTINa  TERMINOLOGY  261 

These  properties  are  further  classified  as  productive  or 
non-productive.  Productive  properties  include  lands,  build- 
ings, structures,  furniture,  tools,  and  apparatus  and  other 
equipment  of  governments  that  are  used  in  connection  with 
the  operation  of  public  service  enterprises.  All  other  prop- 
erties of  governments  are  spoken  of  as  non-productive. 

Street  improvements  is  a  designation  used  by  the 
Bureau  of  the  Census  in  speaking  of  the  land  employed 
for  highway  purposes  belonging  to  governments,  and  the 
structures  and  improvements  upon  such  land,  including  the 
pavements,  sidewalks,  curbs,  bridges,  tunnels,  grades,  and 
fills  for  highway  purposes.  Under  the  term  sewers  are 
included  not  only  the  structures  bearing  that  name,  but 
all  such  structures  as  manholes,  catch  basins,  etc.,  form- 
ing parts  of  the  sewer  system. 

When  the  accounts  of  governments  with  ''properties," 
''street  improvements,"  and  "sewers"  are  properly  kept, 
those  accounts  always  record  "actual  assets."  When,  how- 
ever, through  imperfect  accounting  procedure  the  accounts 
assign  to  the  properties,  street  improvements,  sewers,  etc., 
values  greater  than  the  actual  cost  of  reproducing  them 
in  as  good  condition  as  they  exist,  the  excess  values  re- 
corded are  "nominal  assets." 

Asset  Accounts. — When  a  government  employs  the 
type  of  general  accounts  here  designated  "accounts  based 
on  accruals,"  the  controlled  accounts,  other  than  those 
with  appropriations,  include,  in  theory  at  least,  a  record 
of  all  the  assets  above  mentioned.  It  is  quite  otherwise 
with  "accounts  based  on  cash  transactions."  The  con- 
trolled accounts  on  that  basis  seldom  include  a  record  of 
any  assets  other  than  cash  and  investments.  All  other 
assets,  if  recorded,  are,  in  the  great  majority  of  cities  using 
accounts  based  on  cash  transactions,  recorded  in  what  are 
generally  known  as  "supplementary  or  uncontrolled  ac- 
counts."   In  both  types  of  accounts  the  term  "asset  ac- 


262  ACCOUNTING  TERMINOLOGY 

counts"  is  applied  to  the  controlled  accounts  in  which 
assets  are  recorded. 

A  study  of  the  asset  accounts  of  a  large  number  of 
American  cities  leads  the  officials  in  charge  of  the  census 
statistics  of  cities  to  the  conclusion  that  proper  account- 
ing for  assets  may  be  secured  with  either  type  of  accounts, 
and  that  the  use  of  neither  type  necessarily  does  away 
with  faulty  accounting.  Very  few  cities,  whatever  the 
type  of  accounts  which  they  employ,  have  any  trustworthy 
record  of  the  cost  or  present  value  of  their  "properties," 
and  a  smaller  number  have  any  intelligible  or  trustworthy 
exhibit  of  the  original  cost  of  their  "street  improvements" 
and  "sewers,"  or  of  the  present  cost  of  reproducing  them, 
and  few  have  any  definite  statement  of  the  probable 
amount  to  be  realized  from  their  uncollected  revenues.  So 
long  as  this  state  of  affairs  continues,  the  accuracy  with 
which  the  asset  accounts  of  any  given  government  record 
the  actual  assets  of  that  government  will  measure  the  ad- 
ministrative value  of  those  accoimts  far  better  than  the 
mere  fact  that  the  accounts  are  kept  on  the  basis  of  cash 
transactions  or  of  accruals. 

In  passing,  it  should  be  noted  that  considerable  prog- 
ress has  been  made  in  this  branch  of  accounting  during 
the  last  few  years.  The  Bureau  of  the  Census  has  con- 
tinuously emphasized  the  importance  of  having  correct 
information  with  reference  to  the  value  of  governmental 
properties,  street  improvements  and  sewers,  etc.  As  the 
result  of  this  action,  it  has  been  able  each  year  to  make 
its  statistics  of  the  value  of  governmental  properties  more 
trustworthy  than  those  of  any  previous  year,  although  even 
now  they  are  confessedly  far  from  perfect.  The  Bureau 
of  the  Census,  however,  has  not  included  in  any  preceding 
report  statistics  of  the  value  or  cost  of  street  improve- 
ments and  sewers,  since  it  has  not  in  previous  years  deemed 
the  data  obtained  with  reference  to  these  subjects  suffi- 
ciently trustworthy  to  warrant  publication.    For  a  similar 


ACCOUNTINa  TERMINOLOGY  263 

reason  it  has  hitherto  omitted  all  statistics  of  uncollected 
revenues.  A  correct  statement  of  cash  and  investments 
can  be  made  without  any  exhibit  of  properties  and  street 
improvements  and  sewers,  but  summaries  of  financial  con- 
dition, which  include  on  their  debit  side  only  exhibits  of 
the  two  classes  of  assets  above  mentioned,  are  not  com- 
plete statements  of  governmental  financial  condition.  They 
are,  however,  of  far  greater  administrative  value  than 
more  pretentious  summaries  of  financial  condition,  which 
include  incorrect  statements  of  the  actual  value  of  the  sev- 
eral classes  of  governmental  resources.  The  first  requisite 
in  this  field  is  a  correct  exhibit  of  assets,  so  far  as  any 
presentation  of  their  value  is  given  at  all.  The  extension 
of  accounting  control  over  fixed  assets  may  therefore  with 
profit  be  deferred  until  correct  statements  of  their  value 
have  been  prepared. 

Liabilities. — In  law,  liabilities  are  primarily  the  obliga- 
tions and  responsibilities  of  individuals,  corporations,  and 
governments  to  pay,  deliver,  hold,  use,  or  expend  money, 
or  money's  worth  in  the  form  of  land  or  goods,  or  to  render 
specified  services.  The  term  is  also  used  in  speaking  of 
amounts  of  mone}^,  or  money's  worth  in  the  form  of  land, 
goods,  or  services  which  individuals,  corporations,  and  gov- 
ernments are  under  obligations  to  pay,  deliver,  or  render, 
or  for  whose  use,  payment,  or  expenditure  they  are 
responsible. 

Classification  of  Liabilities. — ^In  accounts,  liabilities  are 
represented  by  credit  entries  and  balances.  The  greater 
number  of  such  entries  and  balances  in  the  liability  ac- 
counts of  enterprises  and  of  governments  represent  the 
legal  liabilities  or  actual  liabilities  above  described,  which 
are  in  a  broad,  general  way  separable  into  two  classes  called 
debts  and  trusts,  or  debt  liabilities  and  trust  liabilities. 
These  liability  accounts  also  contain  the  record  of  amounts 
w^hich  represent  neither  debts  nor  trusts,  but  constitute 
what  are  here  called  nominal  liabilities. 


264  ACCOUNTINa  TERMINOLOGY 

Debts. — In  law,  debts  or  debt  liabilities  are  primarily 
the  obligations  of  individuals,  corporations,  and  govern- 
ments to  pay  or  deliver  money,  goods,  or  other  wealth  to 
specified  parties,  their  hejrs  or  assigns,  or  to  perform  or 
render  specified  services  of  a  money  value  in  their  behalf 
or  at  their  behest.  The  term  is  also  applied  to  amounts 
of  money,  or  money's  worth,  which  have  been  received 
and  must  be  paid  or  delivered  as  stated.  Those  receiv- 
ing and  owing  the  money  are  called  "debtors,"  and  those 
to  whom  it  is  payable  are  called  "creditors." 

Debts  or  debt  liabilities  may  be  classified  upon  many 
different  bases,  and  thus  may  be  given  many  specific  des- 
ignations. Classified  according  to  the  provisions  made  for 
their  payment  or  liquidation,  they  are  called  current  debts, 
funded  debts,  and  floating  debts;  classified  according  to 
the  time  when  due  or  payable,  they  are  called  due  and  de- 
mand liabilities,  liabilities  not  due,  and  liabilities  awaiting 
final  determination  or  adjustment;  and  classified  accord- 
ing to  the  character  of  the  instruments  or  records  which 
evidence  the  debts,  they  are  called  bonds,  notes  payable, 
warrants  payable,  audits  payable,  and  accounts  payable. 

Current  Debts. — The  current  debts  or  current  debt 
liabilities  of  an  enterprise  for  gain  are  those  that  should 
be  met  from  its  current  revenues;  the  current  debts  or 
current  debt  liabilities  of  a  government  are  those  debt 
liabilities  for  the  payment  or  liquidation  of  which  provi- 
sion is  fully  made  by  cash  on  hand,  by  revenues  accrued 
or  accruing,  or  by  other  assets  provided  and  appropriated 
for  that  specific  purpose. 

Funded  or  Fixed  Debts. — The  funded  or  fixed  debts, 
or  funded  or  fixed  debt  liabilities,  of  a  private  enterprise 
or  of  a  government  are  those  debts  evidenced  by  some  for- 
mal instrument,  or  in  some  other  manner,  which  have  a 
number  of  years  to  run  or  upon  which  interest  is  to  be 
paid  in  perpetuity,  but  for  the  amortization  of  which  no 
assets  other  than  those  of  sinking  funds  have  as  yet  been 


ACCOUNTING  TERMINOLOGY  265 

specifically  authorized  or  appropriated.  Originally  the 
term  "funded  debts"  was  applied  only  to  those  debts  for 
whose  amortization  sinking-fund  provisions  had  been  made, 
but  at  present  the  term  is  used  more  or  less  interchangeably 
with  that  of  fixed  debts  in  speaking  of  the  debt  obligations 
specifically  mentioned  above. 

Floating  Debts. — The  floating  debts  or  floating  debt 
liabilities  of  an  enterprise  for  gain  are  those  liabilities 
which  it  has  incurred  for  meeting  current  costs  of  opera- 
tion, but  for  the  liquidation  of  which  it  has  no  available 
resources;  the  floating  debts  or  floating  debt  liabilities  of 
a  government  are  those  debts  for  the  payment  or  redemp- 
tion of  which  there  is  no  money  in  the  treasury  specifically 
designated  or  appropriated,  nor  any  provision  made  for 
obtaining  such  money  by  taxation  or  otherwise. 

Current,  funded,  and  floating  debts  constitute  due  and 
demand  liabilities,  liabilities  not  due,  and  liabilities  await- 
ing final  determination  or  adjustment,  according  as  they 
are  payable  on  demand,  at  the  present  time,  or  at  some 
future  time,  and  according  to  whether  the  amount  payable 
has  been  determined  or  adjusted  or  is  awaiting  such  deter- 
mination and  adjustment. 

The  term  bonds  is  more  or  less  generally  applied  to 
all  written  evidences  of  governmental  indebtedness  given 
under  the  seal  of  the  nation,  state,  or  municipality  issu- 
ing them.  Less  formal  written  evidences  of  indebtedness 
are  most  frequently  referred  to  by  the  specific  designa- 
tions of  notes  payable,  warrants  payable,  and  audits  pay- 
able, while  the  amounts  recorded  only  in  accounts  are  gen- 
erally called  accounts  payable. 

Trusts. — In  law,  trusts  or  trust  liabilities  are  primarily 
the  obligations  of  individuals,  corporations,  or  govern- 
ments to  hold,  use,  or  expend  money  or  other  wealth  in 
the  interest  of  specified  persons  or  for  specified  purposes 
or  objects.  Those  receiving  money  or  other  w^ealth  in  such 
interest  or  for  such  purposes  become  "trustees"  and  not 


266  ACCOUNTING  TERMINOLOGY 

** debtors,"  while  the  persons  in  whose  interest  or  behalf 
the  money  is  held,  used,  or  expended  are  known  as 
**  beneficiaries." 

Trusts  are  of  many  kinds,  which  may  be  grouped  into 
two  general  classes:  (1)  those  obligations  or  responsibili- 
ties which  are  strictly  called  trusts,  and  (2)  those  obliga- 
tions or  responsibilities  in  the  nature  of  trusts  which  are 
involved  in  the  relations  of  agents  and  principals,  of  the 
executors  and  heirs  of  an  estate,  and  of  assignees  and  the 
creditors  of  bankrupt  estates,  etc.  The  trusts  belonging 
to  the  first  class  are  of  two  kinds,  private  and  public. 

Private  trusts  are  trusts  which  concern  individuals  and 
families  and  are  limited  in  duration.  They  are  obligations 
and  responsibilities  to  hold  or  use  specified  amounts  of 
money  or  other  wealth  in  the  interest  of  specified  individ- 
uals, or  to  expend  the  same  in  their  interest  or  at  their 
behest.  In  accounting,  private  trusts  are  amounts  of 
money,  or  its  equivalent  in  the  forai  of  land  or  goods,  held 
for  the  benefit  of  specified  persons  or  to  be  expended  in 
their  interest  or  at  their  behest. 

Public  or  charitable  trusts  are  trusts  which  are  con- 
stituted for  the  benefit  of  the  public  at  large,  or  of  some 
particular  portion  of  this  public  answering  to  a  particular 
description,  such  as  the  poor,  children,  etc.  They  are 
obligations  and  responsibilities  to  expend  specified  amounts 
of  money  or  other  wealth  for  specified  objects  and  pur- 
poses, or  to  hold  the  same  for  such  objects  and  purposes. 
In  accounting,  public  trusts  are  amounts  of  money  or  other 
wealth  which  are  held  for  the  benefit  or  in  the  interest 
of  an  uncertain  and  sometimes  fluctuating  body  of  persons, 
such  as  the  poor,  or  the  children,  or  all  the  people  of  a 
given  to^\Ti  or  city. 

Governmental  Trust  Liabilities.— The  obligations  of  the 
government  to  its  creditors  constitute  its  debts.  The 
classification  of  those  obligations  and  the  designations  ap- 
plied to  them  have  already  been  presented.    These  debts 


ACCOUNTINa  TERMINOLOGY  267 

constitute  claims  or  demands  upon  the  Government,  but 
they  are  not  the  only  claims  upon  the  Government.  The 
other  claims  and  demands  upon  the  Government  are  those 
represented  by  private  tiTists  and  by  public  trusts  for  non- 
governmental uses.  The  most  common  of  the  latter  class 
of  trusts  are  those  created  by  the  acceptance  of  money 
by  cities  for  the  care  of  private  lots  in  cemeteries  and  for 
the  support  of  specified  churches.  These  trusts  are  by 
some  states  classified  as  private  and  by  others  as  public. 
But  whether  legally  designated  ''private"  or  "public" 
trusts,  the  creation  of  the  trust  for  one  of  the  purposes 
specified,  like  the  acceptance  of  money  for  the  purposes 
of  private  trusts,  creates  claims  upon  the  Government 
which,  like  the  claims  of  creditors,  are  properly  recorded 
under  the  legal  designation  "liabilities."  The  several 
classes  of  these  governmental  trusts  creating  claims  upon 
the  Government  should  be  recorded  under  descriptive  titles 
which  will  exhibit  the  character  or  the  nature  or  purpose 
of  the  claims  which  they  represent. 

Nominal  Liabilities. — In  accounting,  the  term  "liabili- 
ties" is  universally  used,  not  only  as  the  common  desig- 
nation of  legal  debts  and  trusts,  but  also  in  referring  to  (1) 
amounts  of  money  or  other  wealth  which  a  private  enter- 
prise or  government  owes  to  one  of  its  funds,  or  which 
one  branch  of  its  business  owes  to  another  branch;  (2) 
amounts  recorded  in  so-called  "liability  accounts"  which 
represent  accounting  offsets  to  the  debit  entries  of  asset 
accounts,  being  amounts  recorded  in  accounts  to  assist  in 
securing  accounting  control  over  specified  contract  obliga- 
tions, such  as  those  for  maintaining  sinking  fund  reserves, 
or  for  other  accounting  purposes;  and  (3)  amoimts  which 
the  enterprise  or  government  may,  under  specified  circum- 
stances, or  subject  to  specified  conditions,  be  called  upon 
to  pay,  deliver,  or  render  in  the  future,  but  for  the  pay- 
ment, delivery,  or  rendering  of  which  there  is  no  present 
obligation.     Liabilities   such    as   those   mentioned   above 


268  ACCOUNTINa  TERMINOLOGY 

under  (1),  (2),  and  (3)  do  not  arise  from  the  reception  of 
wealth  in  any  form  from  others;  neither  do  they  constitute 
claims  upon  the  wealth  in  the  possession  or  control  of  the 
enterprise  or  government  in  whose  accounts  they  are  re- 
corded. They  are  therefore  liabilities  in  name  only,  and 
are  thus  properlj^  spoken  of  as  nominal  liabilities.  In  ac- 
counting, the  nominal  liabilities  mentioned  under  (3)  are 
generally  called  contingent  liabilities. 

Proprietary  Interests. — In  the  accounts  of  enterprises 
conducted  for  gain,  the  claims  of  creditors  and  of  the 
beneficiaries  of  trusts  are  recorded,  as  has  already  been 
stated,  by  credit  entries  in  the  accounts  here  called  bal- 
ance sheet  accounts,  or  accounts  summed  up  in  the  balance 
sheet.  The  property  rights  of  the  owners  or  proprietors 
of  the  same  enterprises,  or  their  equity  in  their  assets,  are 
also  recorded  in  the  same  group  of  accounts  by  credit 
entries.  From  the  fact  that  these  rights  are  thus  recorded 
on  the  same  side  of  the  ledger  accounts  and  balance  sheets 
as  are  liabilities,  they  have  been  by  many  accountants 
included  in  the  balance  sheet  under  the  generic  designa- 
tion * 'liabilities."  The  objections  to  this  procedure  are 
well  stated  by  Mr.  Charles  E.  Sprague,  in  '*The  Philosophy 
of  Accounts,"  pages  46  and  47,  as  follows: 

The  rights  of  others,  or  the  liabilities,  differ  materially  from  the  rights 
of  the  proprietor,  in  the  following  respects: 

(1)  The  rights  of  the  proprietor  involve  dominion  over  the  assets  and 
power  to  use  them  as  he  pleases  even  to  alienating  them;  while  the  creditor 
can  not  interfere  with  him  or  them  except  in  extraordinary  circumstances. 

(2)  The  right  of  the  creditor  is  limited  to  a  definite  sum  which  does  not 
shrink  when  the  assets  shrink,  while  that  of  the  proprietor  is  of  an  elastic 
value. 

(3)  Losses,  expenses,  and  shrinkage  fall  upon  the  proprietor  alone,  and 
profits,  revenue,  and  increase  of  value  benefit  him  alone,  not  his  creditors. 

For  these  reasons  the  proprietary  interest  cannot  be  treated  like  the 
liabilities,  and  the  two  branches  of  the  right-hand  side  of  the  balance  sheet 
require  distinctive  treatment. 

In  order  to  distinguish  fully  between  (1)  the  claims 
of  creditors  and  trust  beneficiaries,  upon  the  assets  or 
properties  of  an  enterprise  for  gain,  and  (2)  the  property 
rights  of  the  owners  or  proprietors  of  such  an  enterprise 


ACCOUNTINa  TERMINOLOGY  269 

in  these  assets  or  properties,  the  Bureau  of  the  Census  in 
its  schemes  of  "accounts"  arranges  the  claims  mentioned 
in  one  group  of  balance  sheet  accounts  under  the  common 
term  ''liabilities,"  as  has  already  been  described,  and  ar- 
ranges the  property  rights  of  the  owners  or  proprietors 
in  a  second  group  of  accounts  to  which  it  gives  the  specific 
designation  proprietary  interests.  In  the  case  of  corporate 
enterprises  for  gain,  the  rights  last  mentioned  may  also 
be  referred  to  as  corporate  capital. 

Classification  of  Proprietary  Interests. — The  proprie- 
tary interests  of  corporations  are  vested  in  their  stock- 
holders, and  are  represented  by  certificates  of  ownership 
called  "certificates  of  stock,"  which  may  be  of  various 
kinds  and  receive  different  designations,  such  as  "first 
preferred  stock,"  "second  preferred  stock,"  "common 
stock,"  etc.  The  proprietary  interests  of  a  private  indi- 
vidual in  the  property  of  unincorporated  enterprises  owned 
or  controlled  by  him  are  not  evidenced  by  any  formal  cer- 
tificates or  other  proof  of  ownership,  and  may  be  consid- 
ered as  constituting  an  undivided  whole  as  contrasted  with 
the  collective  ownership  of  the  stockholders  of  corporate 
enterprises. 

The  proprietary  interests  of  stockholders  in  the  prop- 
erty of  corporations  and  those  of  individual  owners  in  the 
property  of  unincorporated  enterprises  for  gain  controlled 
by  them,  when  considered  from  a  legal  standpoint,  consist 
of  a  single  and  undivided  whole.  For  accounting  purposes 
these  interests,  in  the  case  of  corporations,  are  separated 
into  two  principal  classes  which  are  referred  to  in  the  ac- 
counts as  "stocks"  and  "surplus."  Under  the  term  stocks 
are  included  that  portion  of  the  total  proprietary  interests 
of  the  stockholders  represented  by  the  par  value  of  their 
stocks;  while  under  the  designation  surplus  are  included 
all  other  proprietary  interests. 

When  any  portion  of  the  proprietary  interests  of  a 
corporation  organized  for  gain  Avhich  are  represented  by 


270  ACCOUNTINa  TERMINOLOGY 

its  surplus  is  set  aside  or  appropriated  for  any  specified 
purpose  or  object,  it  is  said  to  be  reserved,  while  all  other 
portions  of  the  surplus  are  said  to  be  unreserved.  Re- 
served surplus  is  frequently  spoken  of  as  surplus  reserv^es. 
These  reserves  may  or  may  not  be  associated  with  "asset 
reserves,"  or  reservations  of  assets.  When  they  are  thus 
associated  the  reservations  of  assets  and  of  surplus  for 
the  same  objects  or  purposes  give  rise  to  special  funds 
which  are  frequently  called  "reserve  funds."  The  most 
common  purposes  for  which  the  proprietary  interests  of 
corporations  for  gain  are  reserved  are  for  meeting  future 
losses  from  bad  debts,  depreciation,  casualties,  and  kindred 
causes.  The  reserves  themselves  always  receive  designa- 
tions indicating  the  purpose  or  object  of  the  reservation, 
and  separate  accounts  are  always  kept  with  each  class  of 
reserves  established. 

Reserves  that  must  be  kept  intact  during  the  life  of 
the  corporation  are  called  permanent  reserves,  and  all 
others  are  called  temporary  reserves.  Reserves  necessi- 
tated by  contracts,  such  as  those  relating  to  sinking  funds 
provided  for  by  mortgages,  are  called  contractual  reserves, 
while  reserves  not  thus  necessitated  are  referred  to  as  non- 
contractual reserves. 

The  proprietary  interests  of  individual  owners  of  un- 
incorporated enterprises  for  gain  cannot  be  separated  into 
two  portions  corresponding  to  the  capital  stock  and  sur- 
plus of  corporations.  These  interests  can,  however,  be 
separated  into  two  portions  designated  respectively  as  re- 
serv^ed  and  unreserved  proprietary  interests.  Under  the 
designation  reserved  proprietary  interests  of  individual 
o^vners  is  included  that  portion  of  their  property  rights 
in  the  enterprise  controlled  by  them  which  has  iDeen  set 
aside  or  reserved  for  specified  purposes.  All  other  prop- 
erty rights  of  the  owners  mentioned  constitute  their  un- 
reserved proprietary  interests.  These  latter  interests  cor- 
respond to  the  interests  represented  by  the  "capital  stock" 


ACCOUNTINa  TERMINOLOGY  271 

and.  "unreserved  surplus"  of  corporate  enterprises  for  gain, 
while  the  reserved  proprietary  interests  receive  specific 
designations  and  call  for  the  same  procedure  in  accounting 
as  do  the  surplus  reserves  of  corporations  organized  for 
gain. 

Attention  has  already  been  called  to  the  fact  that  the 
property  rights  of  the  owners  of  enterprises  for  gain,  or 
their  proprietary  interests,  are  recorded  by  credit  entries 
in  accounts  here  called  proprietary  interest  accounts.  The 
proprietary  interest  accounts  of  the  average  enterprise  for 
gain  not  only  contain  entries  representing  the  actual  pro- 
prietary interests,  or  entries  representing  the  capital  of 
the  proprietors  employed  in  the  enterprise,  but  they  also 
contain  amounts  recorded  by  credit  entries  and  balances 
which  represent  no  actual  property  rights  of  the  owners, 
but  accounting  offsets  to  nominal  assets.  These  entries 
are  referred  to  by  the  Bureau  of  the  Census  as  nominal 
proprietary  interests.  The  most  common  nominal  prop- 
prietary  interests  recorded  in  the  accounts  of  enterprises 
for  gain  are  those  entries  which  represent  corporate  stock 
issued  by  the  enterprise  and  held  in  its  treasury  or  by  one 
of  its  funds  with  investments,  and  revenue  charges  await- 
ing cancellation.  Under  the  latter  term  are  included  losses 
charged  as  expenses  but  not  written  off  in  the  asset  ac- 
counts in  which  are  contained  the  records  of  the  properties 
affected  by  the  losses. 

Interests  of  Beneficiaries. — In  the  accounting  records 
of  colleges,  churches,  and  other  charitable  institutions  the 
claims  of  creditors  upon  the  assets  of  those  institutions 
and  the  interests  of  their  beneficiaries  in  such  assets  are 
recorded  by  credit  entries  in  balance-sheet  accounts.  The 
property  rights  represented  by  these  two  classes  of  entries 
are  as  distinct  and  separate  in  character,  one  from  the 
other,  as  are  the  liabilities  and  proprietary  interests  simi- 
larly recorded  by  credit  entries  in  the  accounts  of  enter- 
prises for  gain.    To  be  of  any  great  administrative  value. 


272  ACCOUNTING  TERMINOLOGY 

the  accounts  of  these  charitable  institutions  should  dis- 
tinguish between  the  claims  of  creditors  and  the  other  prop- 
erty rights  mentioned.  Fully  to  accomplish  this  result, 
the  property  rights  of  beneficiaries  in  the  assets  of  these 
institutions  are  here  called  interests  of  beneficiaries,  and 
the  claims  of  creditors  against  the  institutions  are  given 
the  designation  "liabilities,"  although  in  a  strict  legal 
sense  of  the  word  all  the  interests  of  beneficiaries  may  be 
called  liabilities. 

Some  of  the  interests  of  beneficiaries  of  colleges, 
churches,  and  other  charitable  institutions  result  from  un- 
conditioned gifts,  that  is,  gifts  for  the  general  purpose  of 
the  institution  receiving;  while  others  arise  from  condi- 
tioned gifts,  that  is,  gifts  of  money  or  other  wealth  to  be 
expended,  used,  or  held  for  specified  purposes  or  objects, 
or  to  be  expended,  used,  or  held  subject  to  specified 
conditions.  The  interests  of  beneficiaries  represented  by 
the  unexpected  gifts  of  the  first  class  are  here  called  un- 
reserved interests  of  beneficiaries,  while  those  of  the  second 
class  are  called  reserved  interests  of  beneficiaries.  Some 
charitable  institutions  call  the  reserved  interests  last  men- 
tioned ''funds,"  or  ''special  funds."  The  reserved  inter- 
ests of  beneficiaries  here  referred  to  may  also  receive  many 
specific  designations,  according  to  the  special  purposes  for 
which  the  property  received  by  gift  has  been  reserved  or 
the  conditions  which  constitute  the  reservation. 

Revenue  Accumulations  of  Governments. — The  amounts 
recorded  by  entries  on  the  right-hand  side  of  governmental 
balance-sheet  accounts  and  summaries  represent  in  part 
claims  of  creditors  and  of  the  beneficiaries  of  private  trusts 
upon  the  governmental  assets,  and  in  part  the  interests 
of  the  citizens  and  general  public  in  these  assets.  To  dis- 
tinguish the  claims  first  mentioned  from  the  interests  last 
referred  to,  as  must  be  done  to  secure  any  assistance  from 
accoimts  in  the  proper  administration  of  governmental 
finances,  the  interests  last  referred  to  should  be  given  some 


ACCOUNTINa  TERMINOLOGY  273 

specific  designation.  If  the  state  or  municipality  is  con- 
sidered as  a  proprietor  and  the  accounts  installed  for  the 
guidance  of  its  administration  are  proprietorship  accounts, 
the  interests  may  be  given  the  same  designation  as  in  the 
case  of  enterprises  for  gain,  that  is,  "proprietary  inter- 
ests." If,  however,  the  accounts  of  the  state  or  municipal- 
ity are  fiduciary  in  character,  the  interests  here  referred 
to  may  properly  be  called  interests  of  governmental  bene- 
ficiaries. A  designation  that  is  applicable  for  both  classes 
of  accounts,  and  which  is,  therefore,  better  in  most  respects 
than  either  of  those  given  above,  is  one  which  recognizes 
the  origin  and  character  of  these  interests.  That  designa- 
tion is  revenue  accumulations.  The  term  calls  attention 
to  the  fact  that  the  interest  of  the  citizens  or  general  pub- 
lic in  the  assets  of  a  government  represent  the  revenues 
of  the  past  that  have  not  been  expended  in  meeting  the 
current  costs  of  governmental  maintenance. 

Fully  to  distinguish  between  the  financial  interests  or 
equities  of  the  citizens  of  a  nation,  state,  or  municipality 
in  its  assets,  properties,  and  public  improvements  and  the 
claims  of  others  upon  such  assets,  etc.,  the  claims  referred 
to  should  be  recorded  in  one  group  of  accounts  receiving 
the  name  "liabilities,"  and  the  interests  or  equities  of  the 
citizens  in  a  second  group  called  "revenue  accumulations," 
or  otherwise.  In  the  first  group  should  be  recorded  the 
claims  of  creditors  and  those  of  the  beneficiaries  of  private 
trusts  and  of  public  trusts  for  non-governmental  uses,  and 
in  the  second  the  interests  of  the  citizens,  classified  accord- 
ing to  character. 

Classification  of  Revenue  Accumulations. — ^In  govern- 
mental accounting,  some  credit  entries  are  made  in  the 
balance-sheet  accounts  for  "revenue  accumulations"  which 
are  employed  for  the  purpose  of  securing  accounting  con- 
trol over  specified  classes  of  transactions,  or  for  other  pur- 
poses, and  represent  no  accumulations  of  unexpended  rev- 
enues, but  accounting  offsets  to  actual  or  nominal  assets. 


274  ACCOUNTING  TERMINOLOGY 

All  such  credit  entries  are  here  called  nominal  revenue 
accumulations,  to  distinguish  them  from  amounts  of  actual 
accumulations  of  revenue  for  governmental  purposes.  The 
revenue  accumulations  most  frequently  met  with  in  gov- 
ernmental accounts  are  of  two  distinct  classes:  (1)  Those 
w^hich  are  to  be  held,  used,  or  expended  for  specified  gov- 
ernmental purposes  or  subject  to  specified  conditions;  and 
(2)  those  which  are  to  be  held,  used,  or  expended  in  the 
discretion  of  the  Government.  The  former  class  may  be 
called  reserve,  special,  or  unconvertible  revenue  accumu- 
lations, or  governmental  reserves;  while  the  second  class 
may  be  called  unreserved,  general,  or  convertible  revenue 
accumulations. 

Governmental  Reserves. — The  governments  of  states 
and  municipalities  have  no  capital  stock  as  have  private 
corporations,  and  hence  no  surplus.  The  amounts  of  rev- 
enue accumulations  held  for  future  expenditures,  or  em- 
ployed for  the  acquisition  or  construction  of  the  more  per- 
manent public  improvements,  or  for  the  purpose  of  invest- 
ment, must  from  one  point  of  view  be  considered  as  an 
undivided  w^hole;  and  yet  these  revenue  accumulations  may 
have  been  set  aside  or  designated  for  specified  govern- 
mental purposes  by  the  terms  of  donations  or  of  grants 
from  other  civil  divisions,  or  by  conditions  stated  in  gen- 
eral or  special  appropriation  acts.  While  in  origin  these 
reservations  differ  somewhat  from  those  of  private  enter- 
prises, they  are,  from  the  standpoint  of  the  accountant, 
analogous,  and  therefore  can  with  propriety  be  given  simi- 
lar designations  to  those  applied  to  reservations  of  corpo- 
rate surplus.  Accordingly  they  are  here  spoken  of  as 
"governmental  reserves,"  or  simply  as  "reserves." 

Governmental  reserves,  like  the  surplus  reserves  of 
private  enterprises,  receive  designations  and  are  classi- 
fied primarily  mth  reference  to  the  object  or  purpose  for 
which  they  are  reserved,  or  the  conditions  under  which 
certain  funds  are  received  and  are  held.    The  only  reser- 


ACCOUNTING  TERMINOLOGY  275 

vations  that  are  usually  recorded  in  governmental  trans- 
actions are,  however,  those  shown  in  the  accounts  of 
governmental  funds — general,  special,  and  trust.  These 
reserves,  like  the  surplus  reserves  of  private  corporations 
for  gain,  are  of  two  distinct  classes,  those  which  are  here 
called  permanent  and  temporary. 

Permanent  governmental  reserves  are  those  recorded 
in  governmental  accounts  with  revenue  accumulations 
which  represent  the  principal  of  special  or  trust  funds 
that  has  been  received  with  the  understanding  or  obliga- 
tion that  such  principal  must  be  kept  intact  forever,  and 
only  its  income  expended  for  general  or  special  govern- 
mental purposes. 

Temporary  governmental  reserves  are  those  recorded 
in  governmental  accounts  with  revenue  accumulations 
which  represent  that  portion  of  general,  special,  and  trust 
funds  that  is  at  once  available  for  meeting  current  expenses 
and  has,  by  the  terms  of  general  and  special  appropriation 
acts,  been  reserved  for  specified  expenditures.  The  re- 
serves of  the  general  funds  are  those  represented  by  the 
credit  balances  that  record  the  provisions  and  limitations 
of  the  general  appropriation  acts,  while  the  reserves  of 
the  special  and  trust  funds  are  those  representing  the 
limitations  and  conditions  imposed  by  the  terms  of  special 
appropriation  acts,  such  as  those  accompanying  bond 
issues  and  those  representing  the  limitations  and  condi- 
tions surrounding  the  expenditures  of  so-called  govern- 
mental public  trust  funds  for  governmental  uses. 

Most  American  governments,  in  accounts  wdth  their 
properties  and  public  improvements,  have  but  one  account 
for  the  interests  or  equities  of  the  cities  in  such  properties 
and  public  improvements,  and  that  is  an  account  recording 
a  summary  of  the  amount  of  such  equities.  A  few  cities, 
introducing  improved  accounts  in  the  last  few  years,  have 
separated  those  equities  or  interests  into  two  groups  corre- 
sponding to  the  reserved  and  unreserved  revenue  accumu- 


276  ACCOUNTING  TERMINOLOGY 

lations  of  the  governmental  funds.  The  interests  in  these 
properties,  etc.,  corresponding  to  the  reserved  revenue 
accumulation  of  the  governmental  funds,  are  those  which 
represent  the  gifts  or  other  voluntary  contributions  which 
the  Government  has  received  and  has  expended  in  the 
acquisition  or  construction  of  its  properties  and  public 
improvements  as  called  for  by  the  terms  of  the  givers. 
These  governmental  reserves  may  all  be  called  permanent, 
and  will  in  accounts  be  shown  in  detail  under  specified 
heads  disclosing  the  pui'poses  to  which  the  money  or  other 
wealth  received  has  been  devoted. 

Expenses. — In  governmental  accounting,  expenses  are 
(1)  the  accrued  costs,  paid  or  payable,  of  services,  rents, 
and  materials,  exclusive  of  those  for  permanent  properties 
and  improvements,  utilized  by  nations,  states,  and  muni- 
cipalities for  the  maintenance  and  operation  of  their 
governments  and  for  the  conduct  of  their  business  under- 
takings for  which  they  have  constitutional  or  statutory 
authority;  and  (2)  the  losses  by  depreciation  of  permanent 
properties  and  otherwise.  Expenses  are  the  costs  and 
losses  for  which  no  permanent  or  subsequently  convertible 
value  is  received  or  receivable. 

The  expenses  of  governments  may  be  classified  in 
many  ways.  Classified  with  reference  to  the  objects  for 
which  they  are  incurred  they  are  readily  arranged  under 
the  heads  of  "salaries  and  wages,"  "rents,"  "materials," 
and  "depreciation,"  all  of  which  classes  may  be  subdivided 
into  a  large  number  of  minor  groups,  to  which  may  be 
given  specific  names,  as  in  the  case  of  the  expenses  of 
private  concerns.  Governmental  expenses  are  further 
separable  into  two  principal  groups,  here  called  general 
expenses  and  commercial  expenses. 

General  Expenses. — The  general  expenses  of  the  gov- 
ernments of  nations,  states,  and  municipalities  are  those 
incurred  by  them  in  connection  mth  the  exercise  of  their 
general  govermental  functions.     These  expenses  are,  bj^ 


ACCOUNTINa  TERMINOLOaV  277 

the  Bureau  of  the  Census,  subdivided  into  eight  principal 
groups,  corresponding  to  the  following  division  of  govern- 
mental activities :  I.  General  government ;  II.  Protection  of 
life  and  property;  III.  Health  conservation  and  sanitation; 
IV.  Highways;  V.  Charities  and  corrections;  VI.  Educa- 
tion; VII.  Recreation;  VIII.  Miscellaneous.  The  expenses 
included  in  each  of  these  subdivisions  are  further  classi- 
fied by  the  offices,  departments,  or  otherwise,  into  a  num- 
ber of  groups,  fully  illustrated  by  the  tables  of  this  report. 
Commercial  Expenses. — The  commercial  expenses  of 
the  governments  of  nations,  states,  and  municipalities  are 
those  incurred  by  them  in  connection  with  commercial 
functions.  They  are  divided  into  four  groups,  correspond- 
ing to  the  subdivisions  of  commercial  transactions,  as 
follows : 

(1)  Expenses  of  municipal  service  enterprises  are  the 
total  costs  of  the  operation  and  maintenance  of  munici- 
pal service  enterprises,  or  the  expenses  of  those  depart- 
ments or  offices  of  a  city  which  are  organized  mainly  for 
the  purpose  of  furnishing  the  city  with  some  public  utility 
or  with  some  service  which  most  cities  obtain  from  or 
through  private  enterprises. 

(2)  Expenses  of  public  service  enterprises  are  the  total 
costs  of  operation  and  maintenance  of  the  public  service 
entei^Drises  of  a  nation,  state,  or  municipality,  or  the  ex- 
penses of  those  departments  or  offices  of  a  city  which  are 
organized  for  the  purpose  of  providing  the  public,  or  the 
public  and  the  city,  with  some  public  utility  or  service. 

(3)  Investment  expenses  are  the  total  costs  of  the 
administration  of  sinking,  investment,  and  public  trust 
funds  of  nations,  states,  or  municipalities. 

(4)  Special  service  expenses  are  the  expenses  incurred 
by  nations,  states,  and  municipalities  in  connection  with 
special  services  performed  or  provided  by  any  of  their 
departments  or  offices  other  than  the  public  service  and 
municipal  service  enterprises. 


278  ACCOUNTING  TERMINOLOGY 

Interest. — In  governmental  accounting,  the  term  inter- 
est is  used  as  the  designation  of  the  accrued  costs,  paid 
or  payable,  incurred  by  nations,  states,  and  municipalities 
for  the  use  of  credit  capital  utilized  by  them.  These  costs 
are  separable  into  a  nmnber  of  groups,  according  as  they 
are  classified  with  reference  to  the  purpose  for  which  the 
credit  capital  was  utilized,  or  according  to  the  character 
of  the  governmental  obligations  evidencing  the  indebted- 
ness on  which  the  interest  is  payable. 

Outlays. — In  governmental  accounting,  outlays  are  the 
accrued  costs,  paid  or  payable,  of  lands  and  other  proper- 
ties more  or  less  permanent  in  character,  and  thus  avail- 
able for  more  than  a  single  use,  which  are  owned  or  used 
by  nations,  states,  and  municipalities  in  the  exercise  of 
their  governmental  functions  or  in  connection  with  the 
business  undertakings  conducted  by  them.  The  outlays 
of  governments  are  separable  into  the  same  groups  as  are 
their  general  expenses  and  the  expenses  of  public  utility 
enterprises. 

Investments. — For  a  statement  of  the  nature  of  invest- 
ments see  a  former  page  under  '^ invested  assets." 

Storehouse  Supplies. — Under  the  designation  "store- 
house supplies"  are  included  all  costs,  paid  or  payable, 
of  supplies  purchased  by  governments  in  bulk  for  cities, 
which  are  to  be  distributed  or  assigned  upon  requisition 
to  the  departments,  or  are  to  be  applied  to  current  uses 
or  to  the  construction  of  public  improvements.  They  are 
acquired  under  conditions  which  preclude  the  assignment 
of  their  costs  at  the  time  of  purchase  to  the  purposes  for 
which  they  are  finally  applied.  In  practice,  these  costs 
are  referred  to  under  a  number  of  more  specific  designa- 
tions. 

Revenue  Charges  and  Revenue  Deductions. — In  private 
corporation  accounting  many  business  men  and  account- 
ants employ  the  terms  *' revenue  charges"  and  "revenue 
deductions"  in  referring  to  all  costs  and  losses  that  must 


ACCOUNTINa  TERMINOLOGY  279 

be  met  from  or  charged  to  revenue,  in  order  to  ascertain 
the  income  or  net  profits  accruing  from  the  management 
of  the  enterprise  as  compensation  in  the  form  of  dividends 
or  otherwise  for  the  corporate  capital  or  capital  of  the 
proprietor  employed  therein.  The  costs  and  losses  of 
private  business  thus  chargeable  to  or  to  be  deducted  from 
revenue  are  those  here  called  expenses  and  interest.  In 
accounting  for  governmental  service  or  municipal  service 
enterprises,  where  such  accounting  is  made  on  the  basis 
of  securing  comparability  with  corresponding  private  en- 
terprises, the  terms  "revenue  charges"  and  "revenue 
deductions"  have  the  same  significance  as  stated  above. 
In  accounting  for  the  governments  of  nations,  states,  and 
municipalities,  it  is  to  be  noted  that  all  the  costs  and  losses 
referred  to  above  as  expenses,  interest,  outlays,  invest- 
ments, and  storehouse  supplies,  are  in  one  sense  charges 
against  revenue,  since  they  are  met  from  accumulations 
of  past  revenues  or  present  revenues,  or  from  future  rev- 
enues by  anticipation.  The  costs  and  losses  included  under 
expenses,  interest,  and  outlays  are  the  current  costs  of 
government,  and  may  with  propriety  be  included  under 
the  designation  current  revenue  charges  or  current  rev- 
enue deductions. 

Revenue  Expenditures. — The  term  revenue  expendi- 
tures is  by  many  public  and  private  accountants  employed 
with  the  significance  given  above  to  revenue  charges  and 
revenue  deductions,  and  the  word  "expenditures"  is  also 
employed  as  a  general  descriptive  term,  including  all  that 
is  signified  by  the  words  expenses,  interest,  outlays,  in- 
vestments, storehouse  supplies,  disbursements,  and  pay- 
ments. It  is  sometimes  employed  in  the  present  report 
with  the  general  significance  last  referred  to. 

Revenues  in  Private  Corporate  Business. — In  private 
corporate  business  the  word  revenues  is  the  designation 
most  frequently  employed  at  the  present  time  in  referring 
to  amounts  of  money,  or  money's  worth,  which  corpora- 


280  ACCOUNTING  TERMINOLOGY 

tions  and  enterprises,  other  than  those  engaged  in  trade, 
receive  or  become  lawfully  entitled  to  receive  as  the  result 
of  business  transactions,  the  sale  of  property,  or  the  render- 
ing of  services,  and  as  returns  upon  property  or  interests 
in  property.  Many  accountants  use  the  word  income  with 
the  significance  here  assigned  to  the  word  revenues,  but 
the  word  revenues  is  at  the  present  time  employed  by  the 
larger  number  of  accountants,  many  of  whom  employ  the 
word  income  in  referring  to  the  excess  of  revenues  over 
expenses. 

Governmental  Revenues. — The  revenues  of  nations, 
states,  and  municipalities  are  the  amounts  of  money,  or 
money's  worth,  provided  or  obtained  by  them  for  meet- 
ing those  costs  of  government  called  expenses,  interest, 
and  outlays,  and  are  derived  from  the  following  sources: 
(1)  From  the  exercise  of  the  governmental  powers  of 
taxation  and  police  control;  (2)  from  the  receipt  of  dona- 
tions, gifts,  grants,  and  subventions  for  governmental 
uses;  (3)  from  the  performance  of  ser^dces  for  compensa- 
tion, and  the  furnishing  of  material  objects  for  valuable 
considerations ;  and  (4)  from  the  operation  or  management 
of  the  productive  enterprises,  investments,  and  properties 
of  the  Government. 

The  revenues  or  revenue  of  a  fiscal  year  are  the  amounts 
of  revenues  or  revenue  which  have  been  provided  or  ob- 
tained, or  made  applicable,  for  that  year.  To  distinguish 
between  the  revenues,  or  revenue,  received  and  those 
receivable  to  the  credit  of  a  given  fiscal  year,  the  former 
may  be  called  realized  and  the  latter  authorized  but  un- 
realized. Classified  with  reference  to  their  character,  the 
revenues  or  revenue  of  nations,  states,  and  municipalities 
are,  like  governmental  expenses,  readily  separable  into 
two  classes,  called  respectively  by  the  Bureau  of  the  Census 
general  and  commercial  revenues  or  revenue. 

The  general  revenues,  or  the  general  revenue,  of  a 
nation,  state,  or  municipality  are  the  amounts  of  w^ealth 


ACCOUNTINa  TERMINOLOGY  281 

•unconditioned  upon  the  performance  of  any  specific  service 
to  the  individual  contributor,  provided  or  obtained  as  the 
compulsory  or  voluntary  contributions  of  private  individ- 
uals.^ corporations,  or  other  civil  divisions,  for  defraying 
the  general  costs  of  government.  The  greater  portion  of 
these  revenues  are  derived  from  taxes;  the  remainder  are 
obtained  from  fines  and  forfeits,  gifts,  donations,  grants, 
and  subventions. 

The  commercial  revenues,  or  revenue,  of  a  nation,  state, 
or  municipality  are  the  compulsory  or  voluntary  contribu- 
tions of  private  individuals  and  corporations  levied  and 
collected  as  compensation  for  services  rendered,  material 
objects  furnished,  or  assumed  special  benefits  conferred 
upon  those  from  whom  such  revenues  or  revenue  are  ob- 
tained. Included  in  commercial  revenues  are  those  prop- 
erly called,  or  here  designated,  special  assessments,  privi- 
leges, fees,  charges,  and  sales,  and  those  which  are  secured 
by  the  management  or  operation  of  productive  govern- 
mental enterprises,  investments,  and  properties. 

Taxes. — Taxes  are  compulsory  contributions  of  wealth 
levied,  or  levied  and  collected,  in  the  general  interest  of 
the  community,  from  individuals  and  corporations  with- 
out reference  to  special  benefits  which  the  individual  con- 
tributors may  derive  from  the  public  purposes  for  which 
the  revenue  is  required  or  to  which  it  is  applied. 

Property  taxes,  which  constitute  the  most  important 
single  source  of  American  municipal  revenues,  are  direct 
taxes  upon  property  or  upon  persons,  natural  or  corporate, 
in  proportion  to  their  property''.  Property  taxes  are,  by 
the  Bureau  of  the  Census,  divided  into  two  subclasses 
designated,  respectively,  general  and  special  property 
taxes. 

General  property  taxes  are  those  direct  taxes  which 
are  assessed  and  collected  by  methods  practically  identical 
for  all  kinds  of  property,  while  special  property  taxes  are 
those  which   are   assessed  and  collected  upon  specified 


282  ACCOUNTING  TERMINOLOGY 

property  by  methods  not  applied  to  the  assessment  and 
collection  of  taxes  upon  property  in  general.  All  general 
and  most  special  property  taxes  are  apportioned  accord- 
ing to  the  value  of  the  property  subject  thereto,  and  so 
far  as  they  are  thus  apportioned  are  properly  spoken  of 
as  ad  valorem  taxes. 

General  property  taxes  levied  at  the  same  rates  upon 
all  property  within  the  territory  of  the  taxing  power  are 
here  called  general  levies  of  the  general  property  tax.  Sim- 
ilar taxes  levied  upon  the  property  of  specified  portions  of 
the  territory  of  the  taxing  power,  or  at  varying  rates  in 
different  parts  of  that  territory,  are  here  called  local  levies 
of  the  general  property  tax.  Both  general  and  local  levies 
may  be  for  a  variety  of  objects  and  may  be  authorized  by 
any  civil  division,  and  all  may  receive  specific  designations 
according  to  the  object  or  purpose  of  the  tax,  and  the  civil 
divisions  whose  revenue  they  constitute. 

Business  taxes  are  taxes  collected  from  persons,  natu- 
ral or  corporate,  by  reason  of  their  business,  where  such 
collection  is  not  associated  with  the  granting  of  a  license 
or  permit  to  carry  on  such  business. 

Licenses  or  permit  taxes  are  taxes  collected  from  per- 
sons, natural  or  corporate,  by  reason  of  their  business, 
where  such  collection  is  associated  with  the  granting  of 
a  license  or  permit  to  carry  on  such  business,  or  where 
without  such  license  or  permit  the  individual  or  corpora- 
tion has  no  legal  right  to  engage  in  the  business. 

Poll  taxes  (also  called  capitation  taxes)  are  taxes 
assessed  upon  persons  without  regard  to  their  property. 
They  may  be  levied  uniformly  upon  all  males  of  specified 
ages,  or  graded  according  to  occupation,  or  otherwise. 
Some  of  them  are  levied  in  specified  amounts  against  all 
persons  subject  thereto,  and  others  are  quasi  property 
taxes  based  upon  an  arbitrary  valuation  of  polls.  Poll 
taxes  graded  according  to  occupation  may  also  be  called 
occupation  taxes. 


ACCOUNTINa  TERMINOLOGY  283 

Fines  and  forfeits  are  amounts  accruing  to  the  benefit 
of  nations,  states,  and  municipalities  as  part  of  tlie  pun- 
ishment of  individuals  and  corporations  for  failure  to 
observe  civil  or  criminal  laws,  or  to  perform  the  terms 
of  specified  agreements. 

Gifts  and  donations  are  designations  for  amounts  of 
voluntary  contributions  received  by  governments  from 
private  individuals,  while  grants  and  subventions  are  the 
terms  generally  applied  in  speaking  of  amounts  received 
by  one  government  from  another.  Amounts  received  as 
above,  from  private  individuals  or  from  governments,  may 
be  accepted  either  with  or  without  specified  conditions  as 
to  their  use  or  investment. 

Special  assessments,  like  taxes,  are  compulsory  contri- 
butions levied  under  the  taxing  or  police  power  of  nations, 
states,  and  municipalities  to  defray  the  costs  of  specified 
public  improvements  or  public  services  undertaken  pri- 
marily in  the  interest  of  the  public.  They  differ  from  taxes 
in  that  they  are  apportioned  according  to  the  assumed 
benefits  to  the  individuals  or  corporations  for  whom  the 
services  are  performed,  or  according  to  the  assumed  in- 
crease in  the  value  of  the  property  affected  by  the  improve- 
ment. They  are,  by  reason  of  the  difference  here  stated, 
classified  as  commercial  rather  than  as  general  revenues. 

Privileges. — The  designation  privileges  is  applied  (1) 
to  the  special  contract  rights,  in  and  upon  highways,  grant- 
ed by  special  or  general  laws  and  ordinances  to  specified 
individuals  and  corporations;  and  (2)  to  the  amounts  that 
are  paid  or  payable  to  the  general  treasury  as  compensa- 
tion for  such  rights.  The  rights  which  are  enjoyed  are 
of  the  same  legal  nature  as  those  which  in  private  busi- 
ness are  called  "easements."  These  privileges  are,  by  the 
Bureau  of  the  Census,  divided  into  two  classes  called,  re- 
spectively, major  and  minor.  The  major  privileges  are 
those  which  are  exclusively  enjoyed  by  public  service 
corporations,  and  which  such  corporations  must  possess  in 


284  ACCOUNTING  TERMINOLOaY 

order  to  carry  on  their  operations;  while  the  minor  privi- 
leges are  those  granted  to  public  service  and  other  corpora- 
tions and  to  private  individuals  for  the  privilege  of  utiliz- 
ing for  business  purposes  specified  portions  of  the  street 
or  sidewalk,  or  the  spaces  above  or  below  the  same.  It 
should,  however,  be  noted  that  revenues  derived  from 
minor  privileges  granted  in  connection  with  the  manage- 
ment of  municipal  markets,  and  the  regulation  of  market 
sales  of  merchandise  by  its  producers  in  the  streets,  are 
in  all  cases  to  be  considered  as  parts  of  the  revenues  of 
markets. 

Fees  and  Charges. — Fees  and  charges,  as  distinguished 
from  taxes,  are  compulsory  contributions  of  wealth  which 
are  exacted  from  persons,  natural  or  corporate,  to  defray 
a  part  or  all  of  the  costs  involved  in  some  specified  service 
rendered  by  the  Government. 

Fees  are  amounts  of  money  paid  or  payable  for  serv- 
ices which  are  never  performed  except  by  governments; 
while  charges  are  amounts  of  money  paid  or  payable  for 
services  performed  by  governments  which  are  similar  in 
character  to  those  performed  by  one  individual  for  an- 
other. The  greater  portion  of  all  '^fees"  are  receipts  for 
services  where  the  costs  of  the  same  are  so  well  known 
that  they  are  established  by  statute  and  are  generally  col- 
lected in  advance;  while  '^ charges"  can  be  definitely  deter- 
mined only  upon  completion  of  the  work,  and  advance  pay- 
ments are  only  to  guarantee  the  payment  of  costs  when 
determined. 

Governmental  revenues  obtained  or  secured  from  the 
operation  of  productive  enterprises,  investments,  and  prop- 
erties include  rents,  interest,  receipts  from  sales  of  manu- 
factured products,  etc.,  the  same  as  in  private  business 
management.  The  classification  of  such  revenues  and  the 
terminology  thereof  are  identical  with  those  employed  in 
connection  with  the  revenues  from  similar  sources  of  pri- 
vate productive  enterprises,  investments,  and  properties. 


ACCOUNTINa  TERMINOLOGY  285 

Revenue. — The  revenue  of  a  nation,  state,  or  munici- 
pality is  the  aggregate  amount  of  money  or  other  form 
of  wealth  provided  or  obtained  by  it  for  the  objects  and 
from  the  sources  previously  mentioned  under  ''govern- 
mental revenues." 

The  word  "revenue"  is  also  used  as  a  part  of  many 
compound  terms,  such  as  "revenue  expenditures,"  "rev- 
enue loans,"  "revenue  tariff,"  "revenue  law,"  "revenue 
producing  law,"  "revenue  account,"  etc.,  in  most  of  which 
it  retains  its  significance  as  here  defined.  For  other  legal 
and  accounting  terms  in  which  the  word  "revenue"  is  em- 
ployed with  a  different  meaning,  substitutes  should  be 
adopted  in  order  to  avoid  complexity  and  to  obtain  sim- 
plicity of  terminology  and  clearness  of  statement. 

A  revenue  law  is  a  law  made  either  for  the  direct  or 
the  avowed  purpose  of  creating  or  procuring  revenue  for 
the  support  and  use  of  the  Government,  while  a  revenue 
producing  law  is  one  from  the  operation  of  which  revenue 
accrues  to  the  benefit  of  the  Government. 

A  revenue  account  is  an  account  showing  the  source, 
amount,  and  disposition  of  moneys  received  from  revenue. 
All  revenue  accounts  are  treasury  accounts,  the  latter  term 
being  a  common  or  generic  designation  of  all  accounts 
showing  the  amoimts  of  money  received  into  the  treasury 
from  specified  sources,  and  the  disposition  of  the  same. 
All  monej^s  so  received  are  spoken  of  as  public  moneys,  or 
public  funds. 

Payments. — In  accounting,  payments  are  primarily 
amounts  of  money,  or  its  equivalent,  delivered  or  disbursed 
in  financial  transactions  either  in  the  interest  of  or  for  the 
satisfaction  of  claims  against  the  payer. 

Receipts. — In  accounting,  receipts  are  primarily 
amounts  of  money,  or  its  equivalent,  taken  in  in  financial 
transactions,  either  for  the  benefit  of  the  recipient  or  for 
the  benefit  of  another. 

It  has  already  been  noted  that  the  statistics  of  the 


286  ACCOUNTING  TERMINOLOGY 

financial  transactions  of  cities  compiled  by  the  Bureau  of 
the  Census  are  primarily  statistics  of  governmental  pay- 
ments and  receipts.  These  payments  and  receipts  may  be 
classified  in  many  ways.  The  most  important  classifica- 
tion is  one  based  upon  the  fact  that  some  amounts  of  money 
paid  or  received  lessen  or  add  to  the  cash  in  the  treasury, 
while  others  do  not  lessen  or  add  to  such  cash.  A  classi- 
fication of  the  paj^nents  and  receipts  of  governments  upon 
this  basis  gives  rise  to  two  classes  here  called  real  or  actual, 
and  nominal  or  transfer,  payments  and  receipts. 

Real  or  Actual  Payments. — The  real  or  actual  payments 
of  a  nation,  state,  or  municipality  are  the  amounts  of 
money,  or  money's  worth,  Avhich  its  officials  deliver  to  the 
public,  including  the  governments  of  other  civil  divisions, 
and  which  lessen  the  total  cash  in  its  possession  or  control. 

Real  or  Actual  Receipts. — The  real  or  actual  receipts 
of  a  nation,  state,  or  municipality  are  the  amounts  of 
money,  or  money's  worth,  which  its  officials  take  from 
the  public,  including  the  governments  of  other  civil  divi- 
sions, and  which  add  to  the  total  cash  in  its  possession  or 
control. 

Real  or  actual  payments  and  receipts,  being  in  all  cases 
payments  to  and  receipts  from  the  public,  may  with  pro- 
priety be  called  payments  to  and  receipts  from  the  public. 
The  terms  last  mentioned  are  by  the  Bureau  of  the  Census 
employed  interchangeably  with  the  terms  real  or  actual 
payments  and  receipts. 

The  real  or  actual  payments  and  receipts  of  a  govern- 
ment, or  its  payments  to  and  receipts  from  the  public,  may 
in  turn  be  classified  in  many  ways,  the  most  significant 
classification  being  that  which  separates  the  payments  and 
receipts  for  meeting  the  costs  of  government  from  all  other 
actual  governmental  payments  and  receipts.  Thus  sepa- 
rated, the  payments  and  recei^Dts  of  nations,  states,  and 
municipalities  are  readily  arranged  in  two  groups,  here 
called  payments  and  receipts  for  meeting  governmental 


ACCOUNTINa  TERMINOLOGY  287 

costs,  and  payments  and  receipts  other  than  those  for  meet- 
ing governmental  costs. 

Payments  and  receipts  for  meeting  governmental  costs 
are  the  net  amounts  of  money,  or  other  wealth  expressed 
in  terms  of  money,  which  nations,  states,  and  municipali- 
ties pay  or  expend  for  meeting  costs  of  government,  or 
its  expenses,  interest,  and  outlays,  and  which  they  receive 
from  all  sources.  The  Bureau  of  the  Census  has  in  its 
previous  reports  given  the  name  '* corporate"  to  such  pay- 
ments and  receipts,  for  lack  of  a  more  comprehensive  and 
brief  designation.  It  is  hoped  that  a  more  descriptive 
designation  may  be  suggested. 

Payments  of  nations,  states,  and  municipalities  for 
meeting  costs  of  government  are  readily  separable  accord- 
ing to  the  objects  of  their  payments  into  four  classes: 
(1)  Payments  for  expenses,  (2)  payments  for  interest, 
(3)  pajrments  for  outlays,  and  (4)  payments  for  the  liquida- 
tion of  indebtedness.  These  classes  include  the  net 
amounts  paid  by  governments  for  the  objects  and  pur- 
poses mentioned,  after  amounts  received  to  correct  erron- 
eous payments  for  these  purposes  and  other  counterbal- 
ancing payments  have  been  deducted.  The  payments  for 
the  liquidation  of  indebtedness  which  are  to  be  included 
among  payments  for  costs  of  government  are  the  net  pay- 
ments for  this  purpose,  or  the  excess  of  payments  for  this 
purpose  over  the  amounts  received  for  debt  obligations 
assumed  or  issued  during  a  given  period.  The  ditferent 
classes  of  payments  for  meeting  costs  of  government  are 
frequently  spoken  of  in  this  report  as  the  net  payments 
for  expenses,  interest,  and  outlays,  and  for  the  liquidation 
of  indebtedness.  These  payments  are  readily  separable 
into  the  same  classes  and  given  designations  corresponding 
to  those  for  expenses,  interest,  outlays,  etc.,  of  which  men- 
tion has  previously  been  made. 

The  receipts  of  nations,  states,  and  municipalities 
for  meeting  costs  of  government  are  from  two  sources — 


288  ACCOUNTING  TERMINOLOGY 

revenue  and  public  creditors.  The  receipts  from  revenue 
here  mentioned  are  the  net  amounts  obtained  from  revenue, 
as  above  defined,  after  deducting  all  amounts  received  in 
error  and  returned  or  to  be  returned  in  correction  thereof. 
They  are  readity  classified  according  to  the  specific  source 
from  which  derived,  and  when  thus  classified  will  follow 
the  classification  of  revenues  already  presented.  Receipts 
from  creditors,  included  as  receipts  for  meeting  govern- 
mental costs,  are  the  net  amounts  obtained  from  loans  and 
other  credit  transactions.  They  are  the  excess  of  the  re- 
ceipts which  result  from  the  transactions  mentioned  over 
payments  for  the  liquidation  of  loans  and  other  debt  lia- 
bilities during  any  fiscal  period. 

In  private  business,  amounts  received  from  loans  and 
other  credit  transactions  are  recorded  by  entries  only  in 
the  cash  account  and  in  the  liability  accounts.  The 
amounts  received  are  generally  considered  as  belonging  to 
''capital,"  and  not  to  ''revenue."  The  corresponding 
amounts  received  by  governments  are  by  writers  on  public 
finance — such  as  Henry  C.  Adams,  professor  of  political 
economy  and  finance  in  the  University  of  Michigan; 
Richard  T.  Ely,  professor  of  political  economy  in  the  Uni- 
versity of  Wisconsin;  and  many  others — recognized  as 
being  resources  for  meeting  the  costs  of  government,  and 
thus  to  be, included  in  the  same  general  class  as  "govern- 
mental revenue."  To  distinguish  receipts  from  loans  and 
other  credit  transactions  from  those  obtained  from  what 
has  here  been  defined  as  "revenue,"  the  latter  are  called, 
by  the  writers  mentioned,  receipts  from  "permanent"  and 
"final"  revenues;  while  those  obtained  from  loans  are 
designated  receipts  from  "anticipatory"  or  "temporary" 
revenues.  The  statutes  of  many  American  states  recog- 
nize the  principles  underlying  the  classification  and  term- 
inology employed  by  Professors  Adams  and  Ely  by  call- 
ing short  term  loans  "anticipatory  loans,"  "anticipatory 


ACCOUNTINa  TERMINOLOGY  289 

tax  loans,"   '^anticipatory  revenue  loans,"  ''anticipatory- 
warrants,"  etc. 

Receipts  from  revenues  should,  as  a  rule,  be  arranged 
in  the  same  classes  and  under  the  same  designations  as 
the  revenues  from  which  they  are  obtained;  and  receipts 
from  loans  and  other  credit  transactions  should  be  classi- 
fied according  to  the  nature  of  the  instruments  evidencing 
indebtedness,  or  of  the  credit  transactions  giving  rise 
thereto. 

The  actual  payments  of  cities  other  than  those  for  meet- 
ing governmental  costs  are  amounts  of  money,  or  other 
wealth  expressed  in  terms  of  money,  paid  by  them  to  the 
public,  which  do  not  lessen  the  amount  of  resources  avail- 
able for  meeting  the  costs  of  the  Government.  The  actual 
receipts  of  cities  other  than  those  for  meeting  governmental 
costs  are  those  which  do  not  add  to  the  resources  avail- 
able for  meeting  the  costs  of  government.  These  pay- 
ments and  receipts  are  of  tliree  distinct  classes,  called  by 
the  Bureau  of  the  Census  counterbalancing  payments  and 
receipts,  pajnuents  for  and  receipts  from  investments,  and 
payments  and  receipts  as  agent  or  trustee. 

Counterbalancing  pajTuents  and  receipts  of  a  nation, 
state,  or  municipality  are  amounts  paid  to  and  received 
from  the  same  individual,  or  paid  and  received  for  the 
same  object.  They  are  of  four  distinct  classes:  (1)  Pay- 
ments and  receipts  in  error,  balanced  by  receipts  and  pay- 
ments for  the  correction  of  error;  (2)  payments  and  re- 
ceipts for  accrued  interest  on  bonds  and  on  securities  pur- 
chased by  invested  funds,  balanced  by  later  receipts  and 
payments  of  the  government  or  of  the  funds  originally 
paying  or  receiving;  (3)  receipts  from  debt  obligations 
issued  and  assumed,  balanced  by  amounts  paid  for  the  re- 
demption or  liquidation  of  indebtedness  during  the  same 
fiscal  period;  and  (4)  payments  for  outlays,  balanced  by 
receipts  from  sales  of  real  property,  and  receipts  from 

insurance  companies  on  account  of  losses  by  fire.    Amounts 
B— VIII— la 


290  ACCOUNTING  TERMINOLOGY 

paid  and  received  in  correction  of  error  are  given  the  spe- 
cific designation  of  refunds. 

Investment  payments  of  a  nation,  state,  or  munici- 
pality are  the  payments  for  the  purchase  of  securities  and 
other  investments  by  its  invested  funds,  such  as  those 
designated  sinking,  public  trust,  and  investment  funds; 
and  its  investment  receipts  are  the  amounts  received  by 
its  government  from  the  sale  of  securities  or  other  prop- 
erties belonging  to  the  same  funds. 

Trust  and  agency  payments  and  receipts  of  a  nation, 
state,  or  municipality  are  amounts  of  money  which  its 
government  disburses  and  receives  for  the  government  of 
another  civil  division,  or  disburses  and  receives  as  a  quasi 
trustee  for  private  individuals,  or  for  public  trusts  for 
non-governmental  uses. 

Nominal  Payments  and  Receipts. — The  nominal  pay- 
ments and  receipts  of  a  government  are  amounts  of  money, 
or  money's  worth,  which  one  of  its  divisions,  branches, 
offices,  or  accounts  pays  and  another  receives,  but  which 
do  not  lessen  or  add  to  the  total  cash  in  the  possession  or 
control  of  the  government. 

Nominal  payments  and  receipts  are  by  the  comptroller 
of  New  York  City  called  inter  se  transactions;  by  the 
Bureau  of  the  Census  they  are  most  frequently  called 
transfer  payments  and  receipts,  or  simply  transfers. 

Nominal  payments  and  receipts  of  governments,  when 
classified  according  to  the  character  of  the  transactions 
involved  in  a  transfer,  are  designated  as  ''general  transfer 
pajrments  and  receipts,"  "service  transfer  payments  and 
receipts,"  "interest  transfer  payments  and  receipts,"  "in- 
vestment transfer  payments  and  receipts,"  and  "account- 
ing transfer  payments  and  receipts";  and  when  classified 
with  reference  to  the  divisions,  departments,  or  offices 
between  which,  the  transfer  is  made,  as  "major"  and 
"minor"  transfer  payments  and  receipts. 

General  transfer  payments  and  receipts  are  amounts 


ACCOUNTINa  TERMINOLOGY  291 

of  money,  materials,  or  credits  set  over  by  accounts  or 
delivered  from  one  division,  fund,  enterprise,  office,  class 
of  assets  or  liabilities,  object  of  expenditure,  or  source  of 
revenue  to  another. 

Service  transfer  payments  and  receipts  are  public  utili- 
ties furnished  by  a  governmental  enterprise;  or  the  serv- 
ice performed  by  one  governmental  division,  enterprise,  or 
office;  or  through  one  governmental  fund,  object  of  ex- 
penditiu'e,  or  source  of  revenue,  for  another  governmental 
division,  fund,  enterprise,  office,  object  of  expenditure,  or 
source  of  revenue. 

Interest  transfer  pa3Tiients  and  receipts  are  amounts 
paid  to  a  governmental  fund  or  received  by  it  from  a 
division  of  a  government  as  interest  on  governmental  se- 
curities or  debt  obligations  held  by  the  fund. 

Investment  transfer  payments  and  receipts  are  amounts 
of  securities  or  other  investments  paid  or  delivered  by 
one  fund  and  received  by  another  fund,  or  amounts  of 
governmental  obligations  delivered  by  a  division  of  a  gov- 
ernment to  a  fund,  or  received  by  it  for  a  fund,  and  the 
receipt  or  delivery  of  cash  in  return  therefor. 

Accounting  transfer  payments  and  receipts  are  amounts 
of  money,  or  money's  worth,  which  are  set  over  by  credit 
and  debit  entries  from  one  class  of  accounts  to  another, 
as  from  an  asset  to  a  revenue  account,  or  from  an  expense 
to  a  liability  account. 

Major  transfer  pajniients  and  receipts  are  amounts  of 
money  or  its  equivalent,  transferred  by  one  independent 
division  or  fund  of  a  government  to  another. 

Minor  transfer  payments  and  receipts  are  amounts  of 
money,  or  other  wealth  expressed  in  terms  of  money,  paid 
by  one  office  to  another,  or  set  over  in  the  accounts  of  a 
division  of  a  government  from  one  object  of  expenditure, 
or  source  of  revenue,  to  another. 

Ordinary  and  Extraordinary  Payments  and  Receipts. — 
A  classification  and  terminology  that  have  been  in  use 


292  ACCOUNTINa  TERMINOLOGY 

longer  than  any  of  those  above  mentioned  are  those  that 
separate  governmental  pajonents  and  receipts  into  two 
groups,  called  respectively  ordinary  and  extraordinary. 
This  classification  and  terminology  originated  in  govern- 
mental finance  and  grew  out  of  a  policy  once  observed  by 
all  nations,  states,  and  municipalities  in  meeting  the  costs 
of  their  governments.  This  policy  has  now  been  abandoned 
by  the  greater  number  of  nations,  states,  and  municipal- 
ities, and  in  governmental  accounting  the  names  ordinary 
and  extraordinary  represent  survivals  from  past  methods 
without  administrative  or  other  significance  at  the  present 
time,  although  they  have  been  adopted  and  are  generally 
used  in  private  corporation  accounting  with  their  earlier 
significance  in  governmental  administration.  To  under- 
stand the  earlier  governmental  use  of  these  words  in  the 
classification  and  terminology  of  pajonents  and  receipts, 
it  is  necessary  to  consider  their  present  administrative  use 
in  the  field  of  modern  corporation  accounting. 

One  of  the  objects  of  private  accounting  for  proprietor- 
ship is  to  ascertain  for  each  fiscal  jear  the  outcome  or 
results  of  business  operations  expressed  in  terms  of  profit 
and  loss.  Another  object  is  to  equalize  dividends  from 
year  to  year.  To  assist  in  the  accomplishment  of  these 
two  results,  all  regularly  occurring  expenses  and  all  other 
small  expenses  are  each  year  charged  against  or  deducted 
from  revenue  before  dividends  are  declared.  The  amounts 
thus  charged  are  called  ordinary  expenses,  or  expenses  that 
ordinarily  occur.  When,  however,  exceptionally  large 
costs  or  losses  occur,  such  costs  or  losses  are  called  extra- 
ordinary, and  are  distributed  as  revenue  charges  or  deduc- 
tions over  a  series  of  years,  so  that  they  may  not  disturb 
the  regularity  of  dividends.  Two  methods  are  employed 
for  accomplishing  these  results.  One  is  to  provide  for  ex- 
traordinary costs  and  losses  in  advance  by  setting  aside 
reserves  from  surplus  for  the  exigencies  that  involve  these 
expenditures;  and  the  other  is  to  charge  them  temporarily 


ACCOUNTINa  TERMINOLOaY  293 

to  a  suspense  account,  and  later,  when  it  may  be  found 
most  advantageous  from  an  administrative  point  of  view, 
to  charge  them  to  revenue. 

Modem  governments,  unlike  private  corporations,  can 
seldom  accumulate  large  and  effective  reserve  funds  for 
meeting  extraordinary  governmental  costs.  But  few  Amer- 
ican cities  hold  funds  of  this  character,  and  they  are  prin- 
cipally for  insurance  purposes,  and  the  only  funds  of  the 
kind  that  are  now  held  by  national  governments  are  those 
included  in  *'war  chests"  or  hoards  of  the  precious  metals 
to  meet  the  possible  exigencies  of  war.  At  the  present 
time,  therefore,  the  average  nation,  state,  or  municipality 
employs  but  one  method  for  meeting  extraordinary  or  ab- 
normal costs  and  losses,  and  that  is  by  loans  which  enable 
it  to  do  what  a  private  corporation  accomplishes  through 
a  suspense  account  or  reserve  fund.  These  loans  permit 
the  government  to  distribute  the  burden  of  the  extraordi- 
nary costs  and  losses  upon  the  taxpayers  over  a  series 
of  years,  in  the  same  way  that  the  amounts  charged  or 
held  in  suspense  are  deducted  with  regularity  from  rev- 
enues by  the  private  corporation.  The  extraordinary  gov- 
ernmental costs  to  be  thus  distributed  are  those  which, 
like  the  expenses  of  w^ar,  or  costs  of  a  city  hall,  occur  but 
seldom,  and  may  well  be  distributed  through  a  series  of 
years;  while  the  ordinary  governmental  costs  are  those 
which  regularly  occur,  and  which  should  therefore,  like 
the  regularly  recurring  expenses  and  interest  charges  of 
a  private  corporation,  be  met  every  year  from  revenue. 
The  application  of  the  principles  embodied  in  this  adminis- 
trative policy  makes  the  costs  of  a  village  schoolhouse 
extraordinary,  since  they  occur  only  once  in  twenty  or 
fifty  years;  while  similar  costs  for  schoolhouses  in  cities 
needing  ten  new  schoolhouses  each  year  would  be  ordi- 
nary, because  recurring  in  the  same  way  that  the  ordinary 
expenses  of  a  private  business  recur. 

Few  American  governments  employ  the  words  ordinary 


294  ACCOUNTINa  TERMINOLOGY 

and  extraordinary  in  the  manner  described,  which  corre- 
sponds to  the  use  of  the  word  in  private  business  and  ac- 
counts, and  is  identical  with  the  earlier  governmental  usage 
which  gives  rise  to  the  admirable  method  here  referred  to 
as  adopted  in  private  accounting.  If  any  large  number 
of  governments  so  employed  these  words,  the  classifica- 
tion Avould  admirably  serve  statistical  purposes  and  would 
be  of  large  administrative  value  for  governments.  Unfor- 
tunately the  average  American  city,  as  the  average  Euro- 
pean government,  has  departed  widely  from  the  earlier 
administrative  policy  followed  in  financing  costs  and  loss- 
es, and  of  the  cities  using  the  terms  ''ordinary"  and  ''ex- 
traordinary" no  two  assign  them  the  same  significance. 
As  a  result,  no  comparative  statistical  compilation  can  be 
based  upon  local  classifications  of  payments  and  receipts 
as  ordinary  and  extraordinary.  By  reason  of  this  fact, 
the  Bureau  of  the  Census  makes  no  attempt  to  employ 
the  words  in  its  terminology  of  payments  and  receipts, 
or  to  predicate  any  of  its  classifications  upon  the  usage 
with  which  these  words  are  employed  by  any  given  city. 

Accounting  Summaries. 

Importance. — In  both  governmental  and  private  busi- 
ness, accounts  are  made  of  administrative  assistance 
mainly  through  the  instrumentality  of  summaries,  or 
condensed  statements  of  the  facts  recorded  in  or  de- 
rived from  accounts.  Without  such  summaries  it  is 
impossible  for  an  administrative  officer  or  other  person 
to  gather  from  his  accounts  any  comprehensive  knowl- 
edge of  his  business.  The  number  as  well  as  the  char- 
acter of  the  summaries  that  are  employed  by  any 
enterprise  or  government  determines  the  extent  to  which 
accounts  are  made  of  assistance  in  its  administration.  The 
summaries  employed  in  accounting  are  readily  separable 
into  two  groups,  here  spoken  of  as  general  or  principal, 
and  departmental,  functional,  or  subordinate,  according  to 


ACCOUNTING  TERMINOLOGY  295 

whether  they  relate  to  a  business  in  its  entirety  or  to  the 
various  subdivisions  thereof.  Consideration  is  first  given 
to  the  summaries  employed  in  the  accounts  of  private 
business. 

Summaries  in  Accounts  for  Proprietorship. — Private 
undertakings  conducted  for  gain,  as  has  been  pointed  out, 
make  use  of  proprietorship  accounts.  To  be  of  administra- 
tive assistance,  they  must  disclose  the  property  rights  of 
the  owners,  and  exhibit  the  relation  of  those  rights  to  the 
assets  or  possessions  of  the  undertaking,  and  to  the  claims 
of  creditors  and  trust  beneficiaries  thereupon.  They  must 
also  disclose  the  effect  or  result  of  current  financial  trans- 
actions upon  the  property  rights  of  the  owners.  The  ac- 
complishment of  these  ends  in  accounting  for  proprietor- 
ship requires  two  principal  summaries — one  a  statement 
of  business  condition  and  the  other  of  business  results. 
The  statement  of  business  condition  is  most  commonly 
called,  in  the  case  of  a  solvent  concern,  a  balance  sheet, 
and  in  the  case  of  an  insolvent  one,  a  statement  of  affairs. 
The  summary  of  results  is  called  a  profit  and  loss  account 
or  statement,  or  a  revenue  and  expense  summary,  or  is 
given  some  other  descriptive  designation,  depending  some- 
what upon  the  nature  of  the  business. 

These  summaries  assume  many  forms,  depending  to  a 
large  extent  upon  the  magnitude  and  character  of  the  data 
to  be  summarized,  and  upon  the  facts  or  details  it  is  de- 
sired to  present.  With  all  details  eliminated,  the  form 
assumed  by  the  balance  sheet  of  an  enterprise  for  gain  is 
as  follows: 

Assets.  Liabilities. 

Proprietary  interests. 

In  this  statement,  the  total  liabilities  and  proprietary 
interests  must  equal  the  assets,  and  the  amount  of  pro- 
prietary interests  is  disclosed  by  deducting  the  liabilities 
from  the  assets.  In  like  manner,  the  results  of  the  trans- 
actions of  a  non-trading  concern,  such  as  a  public  service 


296  ACCOUNTING  TERMINOLOGY 

enterprise,  may  be  summed  up  or  stated  in  a  simple  form, 
as  follows: 


Revenues    • $  • 

Expenses    $ 

Interest     


Profit 


The  profit,  in  this  case,  is  always  the  excess  of  revenues 
over  expenses  and  interest.  In  case  the  expenses  and 
interest  are  greater  than  the  revenues,  the  result  is  a  loss. 
But  whatever  the  result  is,  the  amount  of  profit  or  loss 
shown  in  the  statement  should  agree  with  the  difference 
between  the  proprietary  interests  at  the  beginning  and 
those  at  the  close  of  the  period  for  which  the  summary 
of  results  is  prepared,  plus  or  minus  the  changes  made 
therein  during  that  period. 

The  proper  administration  by  a  city  of  a  public  or 
municipal  servdce  enterprise,  such  as  a  water-supply  sys- 
tem or  an  electric  light  and  power  station,  can  be  secured 
only  by  adopting  substantially  the  same  business  methods 
as  are  used  by  private  owners  of  similar  concerns.  The 
emplo}Tnent  of  these  methods  in  their  entirety  involves 
also  a  similar  manner  of  keeping  accounts,  in  order  that 
the  effect  or  results  of  the  operation  of  the  enterprise  upon 
the  city,  either  in  increasing  its  net  expenses  or  in  pro- 
viding revenues  from  the  enterprise  for  other  municipal 
purposes,  may  be  shown.  The  accounts  of  such  municipal 
enterprises,  therefore,  must  be  proprietorship  accounts,  and 
the  summary  statements  called  for  must  be  similar  to  those 
described  in  the  preceding  paragraph. 

Summaries  such  as  those  described  above  are  all  that 
are  employed  by  enterprises  for  gain  whose  only  use  of 
accounts  is  to  disclose  the  amount  of  assets,  liabilities, 
and  proprietary  interests,  and  to  measure  the  profit  and 
loss  for  given  fiscal  periods.  Such  enterprises,  though 
many  in  number,  are  with  the  passage  of  years  coming 
to  represent  a  constantly  decreasing  proportion  of  the 


ACCOUNTINa  TERMINOLOGY  297 

total;  while  an  ever-increasing  number  whether  publicly 
or  privately  owned,  are  striving  to  arrange  their  accounts 
and  provide  summaries  thereof  in  such  a  way  as  to  enable 
the  accountants  and  administrative  officers  to  demonstrate 
when  and  how  gains  are  realized  or  losses  suffered,  and 
also  to  measure  the  amount  of  such  gains  and  losses.  To 
accomplish  the^e  results,  the  accounts  of  this  class  of  enter- 
prises are  divided  and  subdivided  so  as  to  record  sepa- 
rately the  revenues  obtained  from  every  source,  the  costs 
of  every  functional  activity,  and  the  value  of  the  prop- 
erty employed  in  connection  with  each  activity.  Further, 
these  various  divisions  and  subdivisions  of  accounts  are 
summarized  in  accounts  especially  arranged  therefor, 
which  are  given  many  specific  designations,  but  are  re- 
ferred to  in  a  general  way  as  '^controlling  accounts,"  and 
which  are  in  fact  accounting  summaries  subordinate  to 
the  principal  or  general  summaries  described  in  the  pre- 
ceding paragraph.  The  number  and  character  of  these 
controlling  accounts  will  depend  upon  the  nature  of  the 
business  in  w^hich  they  are  employed  and  the  simplicity 
or  complexity,  or  the  varying  number  of  the  accounts 
utilized  for  administrative  purposes. 

Summaries  in  Private  Fiduciary  Accounting. — Neither 
the  balance  sheet  nor  the  profit  and  loss  account  above 
described  is  of  importance  in  the  accounts  of  trustee  or 
agents,  except  where  the  agency  or  trusteeship  involves 
primarily  the  care  of  productive  properties  or  enterprises, 
and  the  trustee  is  required  to  show  how  much  the  owners 
have  gained  or  lost  by  his  management  of  the  property 
or  enterprise.  In  the  case  of  productive  properties,  the 
business  is  conducted  by  the  agent  or  trustee  solely  with 
reference  to  the  property  rights  of  the  owners,  and  hence 
his  accounts  are  proprietorship  accounts.  But  when  the 
agent  or  trustee  is  intrusted  with  the  expenditure  of  money 
or  the  disposal  of  or  acquisition  of  property  in  specified 
ways,  the  accounting  summaries  must  reflect  the  nature 


298  ACCOUNTING  TERMINOLOGY 

of  the  agency  or  trust,  and  the  extent  to  which  the  duties 
and  obligations  under  the  same  have  been  fulfilled.  The 
summary  of  such  accounts  approximates  in  form  the  profit 
and  loss  statement  rather  than  the  balance  sheet  of  an 
enterprise  for  gain.  The  essential  entries  in  such  a  sum- 
mary are  as  follows: 

Amount  received  in  trust,  or  trust  to  be  discharged $ 

Amount  paid  in  trust,  or  trust  discharged 

Amount  on  hand,  or  trust  not  yet  discharged 

When  an  individual  holds  a  fiduciary  position,  such  as 
that  of  executor  of  an  estate  from  which  an  income  or 
revenue  is  derived,  he  generally  accounts  separately  for 
the  principal  and  income,  and  each  summary  embodies  the 
essential  fact  called  for  by  the  condensed  statement  or 
scheme  of  reporting  given  above. 

Summaries  of  fiduciary  accounts  exhibit  the  extent  to 
which  special  fiduciary  obligations  have  been  met  or  dis- 
charged. They  do  not  provide  the  data  for  measuring  the 
efficiency  of  an  agent  or  trustee.  To  accomplish  such  a 
result,  the  summaries  described  must  be  accompanied  with 
supplementary  exhibits,  generally  called  by  accountants 
*' schedules,"  which  must  present  all  the  data  necessary 
for  the  purpose  mentioned.  Such  exhibits,  which  may 
be  given  any  form  that  will  best  present  the  facts  needed 
for  demonstrating  the  efficiency  of  an  agent  or  trustee, 
bear  the  same  relation  to  the  principal  or  general  sum- 
mary above  described  that  the  controlling  accounts  of 
various  orders  do  to  the  general  summaries  of  the  enter- 
prise conducted. 

Summaries  of  Governmental  Business. — As  the  ac- 
counts of  a  commission  merchant  differ  from  those  of  a 
manufacturing  or  transportation  company,  and  as  the  ac- 
counts of  all  three  differ  from  those  kept  by  the  executor 
of  an  estate,  so  governmental  accounts — though  embody- 
ing the  same  fundamental  principles  as  the  accounts  of 
the  classes  mentioned — differ  from  these  accounts.    In  like 


ACCOUNTING  TERMINOLOGY  299 

manner,  governmental  summaries  must  differ  from  those 
employed  by  all  other  classes  of  business,  whether  involv- 
ing the  idea  of  proprietorship  or  that  of  responsibility. 
In  each  case,  the  summaries,  to  be  significant,  must  pre- 
sent data  that  are  of  administrative  importance,  and  in 
forms  that  throw  light  upon  administrative  problems. 
These  problems  of  governmental  business  are  greater  in 
number  and  more  complex  in  character  than  those  of  any 
private  business,  and  for  that  reason  governmental  finan- 
cial data  require  for  their  proper  presentation  in  summary 
fonn  either  the  use  of  a  larger  num.ber  of  simple  state- 
ments or  summaries,  or  the  employment  of  very  complex 
statements.  Consideration  is  first  given  to  some  of  the 
simple  summaries  of  governmental  business. 

1.  Summaries  of  Governmental  Expenditures. — No  ac- 
counts of  nations,  states,  and  municipalities  having  respon- 
sible representative  governments  are  of  greater  adminis- 
trative importance  than  the  accounts  which  summarize  ex- 
penditures and  show  their  relations  to  appropriations. 
Such  accounting  summaries  measure  the  fidelity  with 
which  the  executive  officers  have  complied  with  the  instruc- 
tions given  them  by  the  legislative  branches  of  the  Gov- 
ernment. All  cities  in  the  United  States  with  proper  ac- 
counting systems  prepare  monthly  and  annual  summaries 
of  this  character. 

These  summaries  are  prepared  not  only  by  the  responsi- 
ble heads  of  the  several  administrative  departments,  but 
also  by  the  general  fiscal  officers  of  the  cities— the  comp- 
troller or  auditor,  and  the  treasurer.  The  departmental 
and  general  summaries  of  expenditures  should  be  arranged 
so  as  to  present  the  following  facts:  (1)  The  balance 
brought  forward  from  the  appropriations  of  preceding 
years  formally  reappropriated  for  the  current  year;  (2) 
the  annual  appropriation  or  appropriations  included  in  the 
budget;  (3)  the  appropriations  made  after  the  prepara- 
tion of  the  budget  or  in  addition  thereto;   (4)  the  total 


300  ACCOUNTING  TERMINOLOGY 

appropriations;  (5)  the  matured  bills,  paid  or  payable,  for 
costs  of  government;  (6)  the  unexpended  or  free  balance; 
and  (7)  tlie  amount  of  this  balance  at  the  close  of  the  year 
which  under  the  terms  of  the  appropriation  acts  is  avail- 
able for  the  succeeding  fiscal  period. 

Very  many  American  cities  prepare  monthly  and  annual 
summaries  that  include  the  greater  portion  of  the  data 
mentioned  in  the  foregoing  descriptive  statement;  such 
summaries,  if  statements  of  facts,  are  exhibits  which  show 
how  far  the  executive  officers  of  governments  have  com- 
plied with  the  instructions  given  them  by  the  legislative 
branch  of  the  Government.  But  they  do  not  provide  any 
data  or  means  of  measuring  the  economy  or  efficiency  of 
governmental  administration  any  more  than  the  simplest 
form  of  a  profit  and  loss  account  presents  data  showing 
when  and  how  profits  are  made  and  losses  sustained.  Gov- 
ernmental accounting  summaries,  to  be  of  as  much  admin- 
istrative assistance  as  the  best  accounts  for  proprietor- 
ship, must  provide  the  means  for  measuring  the  economy 
and  efficiency  of  every  branch  of  service  and  the  work  of 
every  administrative  office  or  officer.  This  can  be  done  by 
methods  that  are  substantially  the  same  as  those  utilized 
by  private  enterprises  for  gain  for  disclosing  when  and  how 
gains  are  made  and  losses  sustained.  The  expenditures 
must  be  classified,  according  to  character,  into  those  for 
expenses,  interest,  and  outlays.  They  must  further  be 
divided  and  arranged  in  accounts  which  will  show  the  costs 
of  government  for  each  and  every  branch  of  service  or 
class  of  outlays.  The  accounts  in  which  these  expendi- 
tures are  reported  should  be  arranged,  however,  in  a 
number  of  general  and  subgenera!  groups  according  to  the 
functional  activity  which  they  represent,  in  the  same  way 
as  the  asset  and  expense  accounts  of  private  gainful  enter- 
prises, and  the  accounts  of  each  group  should  be  summar- 
ized in  controlling  accounts  of  such  orders  as  may  be  found 


ACCOUNTINa  TERMINOLOGY  301 

most  convenient,  according  to  tlie  size  of  the  city  and  the 
voluine  of  its  business  activities. 

To  make  these  accounts  of  the  largest  practical  admin- 
istrative assistance,  and  true  measures  of  governmental 
efficiency  and  economy,  governmental  budgets  should  be 
prepared  along  lines  that  will  permit  the  accounts  with 
expenditures  as  above  described  to  be  fully  articulated 
with  the  accounts  with  appropriations.  Laws  should  be 
provided  and  strictly  enforced  to  compel  all  bills  for  ex- 
penses to  be  presented  and  audited  before  the  close  of  the 
year,  and  all  accounts  with  outlays  to  be  so  kept  as  to 
show  approximately  the  value  of  the  work  performed  upon 
all  public  properties  and  improvements.  With  these  and 
kindred  regulations  in  force,  requiring  governmental  busi- 
ness to  be  transacted  by  business-like  methods,  govern- 
mental accounts  and  summaries  of  expenditures  and  ap- 
propriations will  not  only  provide  measures  of  the  fidelity 
with  which  executive  officers  have  complied  with  the 
instructions  of  the  legislative  branch,  but  will  become  the 
basis  of  measuring  the  economy  and  efficiency  of  every 
branch  of  governmental  service.  The  end  here  described, 
however,  can  not  be  fully  attained  until  the  accounts  of 
governmental  expenditures  are  so  arranged  on  common  or 
uniform  lines  as  to  provide  the  means  of  ready  compari- 
sons of  the  expenses  of  each  city  with  those  of  its  neigh- 
bors of  the  same  size  and  operating  under  similar  condi- 
tions. 

A  number  of  American  cities  keep  accounts  with 
appropriations  and  expenditures  in  detail,  as  described 
above.  In  addition,  they  prepare  monthly  and  yearly  sum- 
maries of  their  appropriations  and  expenditures,  which  are 
at  once  exhibits  of  fiduciary  accountability  and  measures 
of  executive  efficiency  and  economy.  Such  detailed  sum- 
maries provide  the  information  under  the  eight  heads 
stated  above  not  only  for  the  city  as  a  whole,  but  also  for 
each  object  of  expenditure  or  appropriation.    The;^  further 


302  ACCOUNTINa  TERMINOLOGY 

show  the  amount  transferred  from  one  appropriation  to 
another. 

Of  the  cities  providing  exhibits  of  expenditures  and 
appropriations  arranged  on  standard  functional  lines,  men- 
tion may  here  be  made  of  Cambridge,  Mass.  The  monthly 
statements  of  that  city,  arranged  on  the  basis  here  de- 
scribed, have  the  great  merit  of  being  imderstood  by  the 
average  city  official  and  taxpayer,  and  of  presenting  facts 
relating  to  the  subject  in  a  form  that  shows  their  legal 
and  administrative  relations  and  provides  a  basis  for  test- 
ing the  economy  and  efficiency  of  administration. 

2.  Summaries  of  Governmental  Receipts. — The  ex- 
penditures of  responsible,  representative  governments 
must  always  conform  to  conditions  stated  in  appropriation 
acts,  and  in  well-governed  states  and  municipalities  ap- 
propriations are  always  based  upon  estimates  of  receipts. 
To  disclose  the  wisdom  of  the  legislative  branch  of  the 
Government  and  its  advisers  in  making  appropriations,  and 
to  make  past  estimates  of  governmental  receipts  an  aid 
in  the  preparation  of  future  estimates,  nations,  states,  and 
municipalities  should  prepare  monthly  and  yearly  sum- 
maries of  estimated  and  realized  receipts,  classified  in  detail 
according  to  source  of  receipt.  To  make  these  summaries 
of  the  greatest  value,  they  should  be  prepared  on  standard 
lines  which  call  for  the  arrangement  of  receipts  in  groups, 
according  to  the  character  of  the  revenue  and  the  other 
sources  from  which  or  through  which  money  is  obtained. 
This  standard  grouping  of  receipts  must-  be  based  upon 
a  classification  devised  by  the  leading  economists  and  stu- 
dents of  governmental  finance  throughout  the  world. 
There  is  already  a  general  agreement  among  these  econ- 
omists and  students,  which  is  in  substance  reflected  in 
the  classification  of  governmental  revenue  receipts  made 
use  of  by  the  Bureau  of  the  Census  in  this  publication,  and 
presented  in  previous  pages.  In  form,  the  city  of  Cam- 
bridge, Mass.,  presents  a  most  comprehensive  and  intelli- 


ACCOUNTINa  TERMINOLOGY  303 

gible  statement  of  the  estimated  and  realized  receipts 
corresponding  to  the  exhibits  of  appropriations  and  ex- 
penditures previously  referred  to. 

Hitherto  the  controlling  accounts  with  receipts  kept 
by  the  great  majoritj?-  of  American  governments  have  been 
records  of  the  amounts  of  cash  passing  into  the  treasury, 
substantially  as  has  been  described  in  preceding  para- 
graphs. Such  accounts  are  measures  of  the  good  judgment 
of  the  governmental  officials  in  making  advance  estimates 
of  governmental  receipts.  They  provide,  however,  no 
measure  or  test  of  the  efficiency  of  executive  officers  in 
collecting  the  amounts  that  should  be  received  by  the 
treasury.  To  provide  the  means  of  testing  that  efficiency, 
accounts  must  be  kept  and  detailed  summaries  prepared 
such  as  are  provided  by  the  controlling  accounts  of  a  pri- 
vate business,  showing  for  each  source  of  revenue  the 
amounts  that  ought  to  be  received  and  the  amounts  that 
actually  are  received.  To  this  end,  accounts  should  be  kept 
with  "revenue"  as  well  as  with  ''receipts"  by  methods  ap- 
proximating those  employed  by  the  most  progressive  pri- 
vate enterprises  for  gain.  Monthly  and  yearly  compari- 
sons in  detail  of  the  revenue  debits  and  revenue  receipts, 
with  explanations  of  the  reason  for  all  variations,  will, 
for  states  and  communities  with  good  revenue  laws,  provide 
the  data  for  demonstrating  the  efficiency  or  inefficiency  of 
fiscal  officers,  and  for  other  states  and  communities  will 
demonstrate  the  need  of  better  systems  of  revenue  laws. 

3.  Summaries  of  Payments  and  Receipts. — The  ac- 
counts of  a  governmental  treasurer  were  originally  kept 
to  demonstrate  the  fact  that  none  of  the  money  received  by 
him  had  been  converted  to  personal  uses,  but  that  all  of 
it  had  either  been  expended  for  public  purposes  as  required 
by  law,  or  that  all  or  a  part  of  it  was  still  in  his  custody. 
The  accounts  of  auditors  and  comptrollers  were  in  the 
beginning  kept  primarily  as  a  check  upon  the  accounts 
of  the  treasurer.    Summaries  of  the  payments  and  receipts 


304  ACCOUNTING  TERMINOLOGY 

of  the  treasurer  were  prepared  at  an  early  date  by  that 
officer  and  also  by  the  comptroller  and  auditor,  and  such 
summaries  in  their  earliest  form  are  still  necessary  in  the 
administration  of  governmental  finances.  In  their  simp- 
lest form  these  summaries  show  the  amounts  of  money  on 
hand  at  the  beginning  and  at  the  close  of  each  fiscal  pe- 
riod. The  progress  made  in  accounting  methods,  how- 
ever, requires  that  modern  governmental  summaries  of  pay- 
ments and  receipts  shall  be  something  more  than  state- 
ments, such  as  those  just  described,  and  in  particular  that 
they  should  state  separately  the  amount  of  cash  at  the 
beginning  and  close  of  the  year  in  the  principal  adminis- 
strative  funds,  such  as  the  general  funds  and  special  funds 
for  different  purposes  requiring  the  reservation  of  cash 
and  expenditures  for  specifi,ed  purposes  only. 

To  be  of  the  greatest  administrative  assistance,  as  well 
as  of  the  greatest  vafue  to  the  general  public,  summaries 
should  classify  payments  and  receipts  as  described  on  pre- 
ceding pages,  at  least  to  the  extent  shown  in  the  analysis 
of  Tables  3  and  4  of  the  present  report.  The  receipts  thus 
summarized  should  include  all  amounts  taken  in  by  the 
treasurer  or  treasurers  for  any  purpose  and  from  any 
source,  and  should  be  classified  so  as  to  show  the  amounts 
received,  respectively,  from  the  public  and  from  depart- 
ments of  the  Government.  The  amounts  received  from  the 
public  should  be  further  separated  so  as  to  show  those 
received  for  meeting  costs  of  government  and  those  received 
for  other  purposes;  and  the  amounts  received  for  meet- 
ing costs  of  government  should  be  arranged  in  groups  which 
will  show  the  amounts  obtained  from  specified  principal 
sources  of  revenue  and  the  amounts  received  from  credit 
transactions  which  increase  the  net  indebtedness  of  the 
nation,  state,  or  municipality. 

On  the  other  side  of  this  summary  the  payments  includ- 
ing all  amounts  paid  out  or  disbursed  by  the  fiscal  officers 
for  any  purpose  and  to  any  person,  should  be  classified 


ACCOUNTINa  TERMINOLOGY  305 

as  'described  above  for  receipts,  into  those  paid  to  the 
public  and  those  paid  to  the  departments  of  the  Govern- 
ment; and  in  turn,  those  paid  to  the  public  should  be  sep- 
arated into  those  for  meeting  costs  of  government  and 
those  for  other  purposes  or  objects.  Payments  for  meet- 
ing costs  of  government  should  include  all  amounts  paid 
out  by  the  preparation  and  delivery,  or  the  preparation 
only,  of  audited  bills  or  vouchers,  or  warrants  by  the  comp- 
troller or  auditor,  for  the  principal  classes  of  expenses, 
interest,  and  outlays,  and  all  amounts  disbursed  by  the 
treasurer  under  circumstances  or  conditions  which  lessen 
the  aggregate  of  public  indebtedness. 

Such  a  summary  will  disclose  at  a  glance  the  relation 
of  correct  administration  to  public  indebtedness.  The  na- 
tion, state,  or  municipality  which  has  an  excess  of  revenue 
over  all  current  costs  of  government,  including  expenses, 
interest,  and  outlays,  is,  for  the  time  being  at  least,  de- 
creasing its  indebtedness.  Such  a  decrease  may  be  the 
result  of  conservative  and  economical  administration  which 
uses  public  credit  only  for  meeting  exceptional,  non-recur- 
ring, or  ^^extraordinary"  costs  of  government;  or  it  may 
result  from  the  fact  that  the  Government  has  reached  the 
limit  of  its  debt-incurring  power,  and  as  a  result  of  neces- 
sity, must  pursue  a  saner  administration  that  in  some  re- 
spects is  along  the  same  lines  as  an  administration  of  the 
character  just  mentioned.  The  nation,  state,  or  munici- 
pality, whose  expenses  and  interest  exceed  or  even  ap- 
proximate the  amount  of  its  revenue,  has  entered  upon  a 
course  which  if  not  changed  will,  even  with  the  greatest 
increase  in  local  wealth,  sooner  or  later  bring  it  to  the 
limit  of  its  borrowing  power.  Governmental  officials  and 
writers  on  public  finance  are  not  agreed  as  to  what  should 
be  the  true  policy  of  nations,  states,  and  municipalities 
with  reference  to  public  indebtedness;  and  at  the  present 
time  definite  facts  relating  to  the  amount  of  public  indebt- 
edness and  the  relation  of  current  governmental  transac- 


306  ACCOUNTING  TERMINOLOGY 

tions  to  that  indebtedness  are  needed  even  more  than  dis- 
cussion of  the  true  policy  of  governmental  administration. 
Under  such  circumstances,  nothing  can  be  done  by  govern- 
mental fiscal  officers  and  accountants  to  assist  in  opening 
the  way  for  the  final  determination  of  the  true  policy  of 
governments  with  reference  to  public  debt  that  would 
prove  to  be  of  as  much  value  as  the  presentation  of  sum- 
maries such  as  those  above  described,  which  show  clearly 
and  exactly  all  the  facts  about  revenues  and  costs  of  gov- 
ernment as  outlined,  and  disclose  the  present  drift  of  the 
nation,  state,  or  municipality  with  reference  to  public 
indebtedness. 

To  be  of  the  greatest  value,  a  summary  of  payments 
and  receipts  such  as  that  described  must  be  based  upon 
accurate  accounts,  and  be  associated  with  promptness  and 
dispatch  in  the  conduct  of  business.  The  payments  to  be 
included  in  the  summary  of  expenses,  interest,  and  out- 
lays are  those  represented  by  the  audited  bills  or  warrants 
drawn  by  the  auditor  or  comptroller  upon  the  treasurer. 
If  such  bills  or  warrants  are  always  issued  promptly  after 
presentation  of  just  claims,  they  represent  the  current  costs 
of  government  as  perfectly  as  the  expense  account  of  the 
best-managed  private  corporations  represent  current  costs 
of  operation.  If,  however,  claims  are  not  presented  when 
they  accrue,  or  are  not  audited  and  paid  by  warrant 
promptly  upon  presentation,  neither  the  accounts  nor  the 
summaries  are  records  or  statements  of  the  current  costs 
of  government,  and  such  accounts  and  summaries  will  con- 
tinue to  have  a  considerable  margin  of  error  until  the  Gov- 
ernment corrects  its  method  of  transacting  business.  This 
is  far  more  vital  than  changes  in  methods  of  accounting, 
which  are  to  be  considered  factors  for  good  only  so  far  as 
they  assist  in  stimulating  and  enforcing  correct  methods 
of  administering  business. 

4.  Summary  of  Budgetary  Expenditures. — The  gov- 
ernments of  most  American  cities  prepare  more  or  less 


ACCOUNTING  TERMINOLOGY  307 

elaborate  budgets  or  statements  of  expenditures  to  be  met 
from  current  revenue.  Some  of  these  cities  include  all 
their  costs  of  government  in  such  a  budget,  and  thus  meet 
from  revenues  not  only  their  current  operating  expenses 
but  all  amounts  required  for  outlays  and  those  to  be  trans- 
ferred to  sinking  funds  or  employed  for  other  specified 
purposes.  Summaries  of  receipts  and  payments  arranged 
as  stated  in  the  preceding  section  will  show  the  relation 
of  revenue  receipts  to  costs  of  government,  and  the  formal 
payments  for  the  liquidation  of  indebtedness.  These  sum- 
maries, however,  will  not  exhibit  the  relation  between  the 
revenue  receipts,  or  revenue,  and  the  paj^ments  other  than 
those  for  current  expenses  and  interest  made  specially 
payable  from  current  revenue  by  the  terms  of  the  appro- 
priation or  revenue  acts.  A  complete  summary  of  revenue, 
or  revenue  receipts,  and  budgetary  expenditures  or  the 
expenses  and  other  charges  made  specifically  chargeable 
to  current  revenue,  is  a  statement  of  considerable  admin- 
istrative significance  and  assistance.  Such  statements  are 
at  the  present  time  very  frequently  presented  under  the 
term  *' summary  of  revenue  and  expense,"  a  term  which 
is  not  strictly  applicable  to  them,  since  the  designation 
"expense"  is  not  a  proper  one  to  use  in  referring  to 
amounts  transferred  to  sinking  funds,  disbursed  for  meet- 
ing the  costs  of  outlays,  or  for  similar  purposes,  even 
though  paid  from  revenue.  A  better,  because  more  de- 
scriptive, designation  for  referring  to  all  these  amounts 
made  payable  from  revenue  by  the  specific  terms  of  the 
appropriations  is  "budgetary  expenditures." 

5.  Summaries  of  Revenues  and  Expenses.— A  govern- 
mental summary  of  revenues  and  expenses  is  a  statement 
which  shows  on  the  one  side,  either  in  a  single  entry  or 
in  a  number  of  specific  entries,  the  amount  of  accruing 
revenues  for  a  given  fiscal  year,  and  on  the  other  side  the 
accruing  expenses  for  the  same  period.  By  accruing  rev- 
enues is  meant  the  amount  of  revenue  that  is  entered  in 


308  ACCOUNTING  TERMINOLOGY 

the  accounts  to  the  credit  of  that  year.  In  practice,  it 
is  the  amount  charged  in  revenue  accounts  as  that  which 
ought  to  be  collected  from  various  sources  for  govern- 
mental uses.  By  accruing  expenses  are  meant  those  which 
have  been  approved  and  audited  by  the  proper  account- 
ing officer.  In  all  the  best-managed  cities  the  accruing 
expenses  here  mentioned  are  identical  with  the  warrant 
payments  for  expenses  by  the  comptroller  or  auditor. 
They  correspond  to  the  amounts  that  would  be  charged 
to  expenses  in  an^^  well-managed  corporation.  With  poor 
governmental  management  the  warrant  pajrtnents  are 
more  or  less  defective  measures  or  statements  of  the  costs 
of  government,  but  no  more  trustworthy  or  accurate  ex- 
hibit of  such  costs  can  be  obtained  by  any  system  of  ac- 
counting until  or  unless  the  business  administration  of 
the  city  is  improved. 

In  theory,  at  least,  accrued  governmental  revenues 
correspond  to  the  accrued  revenues  of  a  private  business, 
which  are  always  employed  to  measure  the  current  profit 
or  loss  of  an  enterprise.  The  accrued  revenues  of  a  pri- 
vate business  always  tend  to  increase  the  profit  or  decrease 
the  current  losses.  For  administrative  purposes  these  ac- 
cruals must  be  placed  over  against  the  accruals  of  expens- 
es. In  the  business  of  governments  considered  as  the 
agents  of  the  nation,  state,  or  municipality,  accrued  rev- 
enues never  become  factors  in  any  important  administra- 
tive problem  other  than  that  which  concerns  their  collec- 
tion, to  which  attention  has  previously  been  called.  Ap-^ 
propriations  are  made  on  the  basis  of  estimates  of  reve- 
nue receipts,  and  not  revenue  charged  or  to  be  charged 
on  the  books;  and  in  this  and  in  other  ways  revenue  re- 
ceipts and  warrant  expenses,  and  other  costs  of  govern- 
ment met  by  warrants,  become  the  essential  factors  in  the 
important  administrative  problems  of  government.  For 
this  reason,  such  summaries  of  receipts  and  payments  as 
those  already;  described  become  of  supreme  administra- 


ACCOUNTING  TERMINOLOGY  30i 

tive  value  and  importance,  and  summaries  of  revenues  and 
expenses  are  only  statements  of  academic  or  theoretical 
significance  notwithstanding  their  vital  importance  in  pri- 
vate accounting. 

6.  Miscellaneous  Summaries. — In  addition  to  the  fore- 
going summaries  which,  with  the  exception  of  the  type 
last  mentioned,  are  prepared  in  one  form  or  another  by 
most  American  cities,  there  are  many  other  kinds  of  sum- 
mary statements  employed  in  connection  with  the  financial 
administration  of  municipalities.  The  great  majority  of 
such  statements  are  arranged  for  the  purpose  of  summariz- 
ing data  that  are  of  special  administrative  significance  to 
the  city  preparing  them,  by  reason  of  the  operation  of 
state  laws  or  specific  local  regulations.  In  the  present 
connection,  however,  it  will  be  sufficient  to  mention  only 
two  of  these  summaries. 

In  cities  where  general  property  taxes  are  never  col- 
lected in  the  year  when  levied,  or  in  the  fiscal  year  on 
whose  accounts  they  are  carried,  some  account  must  be 
kept  which,  like  a  summary  statement,  will  disclose  the 
relation  between  the  tax  levies  and  the  revenue  loans 
issued  in  anticipation  of  their  collection.  Such  summaries 
may  never  be  included  in  formal  printed  reports,  but  they 
constitute  important  memoranda  for  the  guidance  of  fiscal 
officers  issuing  and  of  bankers  providing  governmental 
loans. 

A  summary  of  the  same  general  nature  is  prepared 
by  cities  showing  that  their  sinking  fund  assets  and  their 
method  of  accumulating  such  assets  suffice  to  provide  the 
funds  for  liquidating  all  loans  when  due. 

7.  Summaries  of  Current  Funds  and  Accounts.— All 
the  summaries  hitherto  described  are  simple  in  form  and 
easily  understood  by  all.  With  few  exceptions  each,  di- 
rectly or  indirectly,  shows  the  relation  of  two  classes  of 
financial  data.  The  most  vital  facts  in  each  case  may  be 
summed  up  in  a  balance-sheet  form,  although  some  of  them 


310  ACCOUNTINa  TERMINOLOGY 

may  be  presented  better  in  a  form  that  approximates  that 
of  a  private  profit  and  loss  account.  Many  cities  content 
themselves  with  keeping  accounts  and  printing  separate 
summaries  such  as  those  already  described;  while  others 
endeavor  to  include  part  or  all  of  the  data  included  in 
summaries  of  the  types  described  under  1,  2,  and  3,  together 
mth  certain  other  data,  in  a  single  statement  which  may 
be  called  a  statement  of  condition,  corresponding  in  gov- 
ernmental business  to  that  section  of  the  balance  sheet 
of  a  private  business  which  includes  current  assets,  lia- 
bilities, and  proprietary  interests.  Such  summaries  are 
given  many  different  names,  and  may  best  be  described 
by  calling  them  summaries  of  current  funds  and  accounts. 
Such  a  summary  will  show  at  the  beginning  of  a  fiscal  year 
on  the  debit  side  (1)  the  cash  on  hand,  as  indicated  in 
the  outline  of  *' summaries  of  receipts  and  payments,"  and 
(2)  the  estimated  receipts  for  meeting  governmental  costs, 
as  described  under  ** summaries  of  governmental  receipts"; 
and  on  the  credit  side  (3)  the  debt  liabilities  to  be  met 
during  the  current  fiscal  period  or  directly  from  the  assets 
credited  to  that  period  and  (4)  the  expenditures  authorized 
for  the  fiscal  period  by  general  and  special  appropriation 
acts.  The  balance  between  the  two  sides,  if  on  the  credit 
side,  represents  current  resources  available  for  future  ap- 
propriation or  for  meeting  indebtedness,  or  for  making 
investments;  while  a  debit  balance  marks  a  prospective 
deficiency  which  must  be  met  by  the  creation  of  a  per- 
manent or  floating  debt. 

The  amounts  to  be  included  in  a  summary  such  as  is 
here  outlined  for  any  date  subsequent  to  the  opening  of 
the  fiscal  year  will  be  for  (1)  and  (3J,  respectively,  the 
cash  in  the  treasury  and  the  outstanding  liabilities  at  the 
date  of  the  summary.  The  corresponding  amounts  to  be 
included  under  (2)  will  be  those  of  the  original  estimated 
receipts  less  the  cash  obtained  from  sources  that  have  not 
created  a  liability  to  be  included  under   (S);  and  the 


ACCOUNTING  TERMINOLOGY  311 

amounts  to  be  similarly  included  under  (4)"  will  be  those 
of  the  original  appropriations  less  the  expenditures  pre- 
viously made  in  consonance  with  the  terms  of  the  appro- 
priation acts. 

Such  a  summary  is  not  a  statement  of  a  business  em- 
ploying proprietorship  accounts,  but  of  one  employing 
fiduciary  accounts.  It  shows  on  the  one  side  the  cash  in- 
trusted to  the  Government  for  governmental  uses,  and  the 
amounts  which  the  Government  is  expected  to  realize  from 
specified  sources  for  those  uses,  or  the  failure  to  realize, 
which  it  is  expected  to  explain.  It  exhibits  on  the  other 
side  the  debts  and  expenditures  to  be  met  or  authorized 
to  be  met  from  the  amounts  first  mentioned,  and  thus  the 
specific  uses  to  which  the  amounts  first  mentioned  are  ap- 
plied. Such  a  summary,  therefore,  brings  into  one  state- 
ment an  exhibit  of  the  current  administrative  problems 
of  the  executive  officers,  including  the  fiscal  and  other 
officials. 

On  previous  pages  mention  has  been  made  of  the  fact 
that  in  recent  years  some  American  cities  have  installed 
proprietorship  accounts  to  take  the  place  of  the  earlier 
fiduciary  accounts.  The  great  majority  of  accountants  who 
are  engaged  in  installing  these  accounts  insist  that  in  such 
a  scheme  it  is  improper  to  include  in  a  summary  of  condi- 
tion such  as  the  one  here  referred  to  any  such  exhibit  as 
that  mentioned  under  (2).  These  accountants  contend 
that  from  the  standpoint  of  proprietorship  it  is  inadmis- 
sible to  include  in  the  summary  any  revenues  that  have 
not  accrued  and  become  charges  against  definite  persons. 
If  this  contention  is  soimd  in  theory  and  law,  as  it  appears 
to  be,  these  accounts  should  show  in  the  summary  of  cur- 
rent funds  and  accounts  only  the  revenues  which  have 
actually  accrued.  The  summary  as  thus  prepared  would 
show  a  greatly  fluctuating  proprietary  interest  through  the 
year,  as  if  the  city  credit  or  basis  of  credit  were  fluctuat- 
ing with  the  formal  levying  of  taxes  and  the  collection  of 


S12  ACCOUNTINa  TERMINOLOGY 

revenue.  As  stated  on  previous  pages,  the  test  of  all  ac- 
counts is  in  the  administrative  assistance  which  they 
render  the  officials  responsible  for  good  government,  and 
time  alone  can  decide  which  of  the  two  systems  of  accounts 
is  more  desirable — those  first  described,  whose  summaries 
show  each  month  what  the  executive  officers  are  author- 
ized to  do  and  the  resources  on  which  the  authorizations 
are  based,  or  those  of  the  latter  type,  whose  summaries 
disclose  not  what  is  to  be  done  and  how  it  is  to  be  done, 
but  what  has  been  formally  charged  as  amounts  owed  by; 
or  owed  to  the  city. 

8.  Summary  of  Investments,  Properties,  and  Accumu- 
lations.— The  summaries  heretofore  described  are  primarily 
exhibits  of  official  responsibility  and  public  obligations  to 
be  met  and  the  resources  provided  or  expended  for  meet- 
ing them  during  a  limited  fiscal  period,  principally  in  the 
future;  but  governmental  accounts  should  not  only  look 
to  the  future  but  be  records  of  the  past.  They  should 
summarize  the  outcome  of  past  transactions  so  far  as  their 
results  provide  properties  and  public  improvements  for  the 
use  of  the  present  and  future,  or  lay  burdens  of  debt  and 
taxation  upon  the  present  and  future.  The  accounts  in 
which  these  records  are  kept  may  be  made  an  essential 
part  of  the  circle  of  accounts  from  which  are  obtained  the 
data  for  the  summary  last  described,  or  they  may  be  re- 
corded in  an  independent  circle  of  accounts,  as  may  seem 
most  convenient.  i 

A  governmental  summary  which  will  provide  the  infor- 
mation outlined  above  must  show  on  the  one  side  (1)  all 
funds  with  investments  which  are  held  for  governmental 
uses,  such  as  sinking  funds,  public  trust  funds  for  gov- 
ernmental uses,  and  general  investment  funds,  and  (2)  all 
governmental  properties — productive  and  non-productive 
— and  public  improvements;  and  on  the  other  side  (3)  the 
fixed  or  funded  debts  incurred  in  the  past;  (4)  the  amounts 
of  the  fxrnds  and  properties  acquired  as  the  result  of  free 


ACCOUNTINa  TERMINOLOGY  313 

contribution  from  the  public,  either  with  or  without  speci- 
fied conditions,  and  those  set  aside  for  specified  purposes; 
and  (5)  the  amounts  acquired  from  compulsory  revenues. 
All  amounts  included  under  (4)  and  (5)  constitute  revenue 
accumulations  for  the  more  or  less  permanent  uses  of  the 
Government,  and  correspond  to  the  proprietary  interests 
of  an  enterprise  conducted  for  profit  and  employing  pro- 
prietorship accounts.  Of  these  amounts,  those  included 
under  (4J  correspond  to  those  amounts  which,  in  the  case 
of  a  private  enterprise,  are  reserved  or  constitute  its  sur- 
plus reserves. 

9.  General  Governmental  Summaries. — A  few  govern- 
mental accountants  and  governmental  officers  are  giving 
thought  to  the  preparation  of  general  summaries  of  gov- 
ernmental financial  condition.  They  would  include  in  such 
summaries  all  data  presented  in  the  summaries  outlined 
under  7  and  8.  No  summary  along  this  line  has  yet 
been  prepared  that  has  been  satisfactory  to  more  than  a 
limited  number  of  those  interested,  since  it  has  either  been 
so  complex  as  to  be  readily  understood  by  only  a  few,  or 
it  has  omitted  some  facts  of  administrative  importance, 
and  thus  has  been  an  imperfect  and  often  misleading  ex- 
hibit. Until  or  unless  some  more  simple  method  of  sum- 
marizing all  the  financial  data  of  administrative  impor- 
tance is  devised  than  has  yet  been  presented  to  the  public, 
[the  average  city  official  and  the  average  private  citizen 
will  find  far  more  of  interest  and  of  administrative  value 
in  the  summaries  previously  described  than  in  the  one  here 
referred  to. 

Names  of  Governmental  Summaries. — The  average  com- 
mercial accountant  knows  of  but  two  business  summaries^ 
the  one  which  he  calls  ''balance  sheet"  and  the  one  called 
"revenue  and  expense"  or  "profit  and  loss"  account. 
"When  he  is  called  in  as  an  expert  to  arrange  governmental 
accounts,  he  applies  these  names  with  but  little  discrimina- 
tion to  governmental  statements,  and  hence  we  find  Amer- 


314  ACCOUNTINa  TERMINOLOGY 

ican  cities  referring  to  all  the  summaries  mentioned,  re- 
spectively, imder  1,  2,  3,  7,  8,  and  9  as  balance  sheets, 
or  trial  balances,  although  no  one  city  applies  the 
designation  mentioned  to  more  than  one  of  these  state- 
ments. None  of  these  governmental  summaries  above  re- 
ferred to,  and  none  of  the  others  which  have  been  de- 
scribed, is  a  true  balance  sheet  in  the  sense  in  which  that 
term  is  employed  in  private  business  for  gain.  They  are 
all  governmental  statements,  and  should  be  given  designa- 
tions which  are  as  little  as  possible  associated  with  sum- 
maries of  private  enterprises  for  gain,  in  the  same  way 
that  those  summaries  are  distinct  in  name  and  in  form 
from  those  for  private  fiduciary  accountiQg. 


SECTION  C. 

SOME  RECENT  CHANGES  IN  GOVERNMENT 
ACCOUNTING* 

BY  H.  PARKER  WILLIS,  Ph.  D. 

Government  methods  of  transacting  business  are  not 
of  the  inadequate  type  sometimes  described.  They  are 
in  the  main  well-suited  to  their  purposes,  and,  though  far 
more  expensive  than  those  which  would  be  applied  by  a 
commercial  establishment,  they  are  usually  reliable.  Their 
chief  defect  has  come  from  the  entire  independence  of 
different  departments  of  the  Government,  the  jealousy  of 
cabinet  officers  toward  one  another,  the  inertia  of  bureau- 
cratic officials  remaining  in  office  year  after  year  and  un- 
willing to  modify  old  methods  in  spite  of  changes  in  busi- 
ness conditions.  Because  of  these  factors 'in  the  situation, 
and  because  the  development  of  government  departments 
has  been  rapid  and  irregular  within  recent  years,  new 
functions  being  taken  over  by  a  process  of  accretion  with- 
out corresponding  organic  changes  in  administrative  struc- 
ture, a  growing  number  of  readjustments  and  improve- 
ments have  been  called  for  by  the  actual  conditions  of  the 
public  service.  Needed  changes  included  not  only  altera- 
tions in  methods  of  accounting,  but  also  innovations  in 
modes  of  purchasing  supplies,  conducting  the  manufactur- 
ing operations  of  the  Government,  and  checking  the  dis- 
bursement of  money.  Attention  has  often  been  called  to 
the  necessity  of  such  changes  prior  to  the  administration 
of  President  Roosevelt.  The  postal  scandals,  the  unsatis- 
factory and  discreditable   conditions  in  the  Government 

*  Repronted  from  Journal  of  Accounting,  April,  1909. 

315 


816  HENRY  PARKER  WILLIS 

Printing  Office,  and  the  poor  quality  of  organization  in  the 
post-office  department,  as  well  as  disparity  in  methods  of 
purchasing  supplies,  once  more  emphasized  the  need  al- 
ready recognized  early  in  Mr.  Roosevelt's  term  of  office. 
Coupled  with  these  were  several  striking  and  unfortunate 
shortages  on  the  part  of  disbursing  officers  of  the  United 
States.  In  order  to  ascertain  the  direction  properly  to  be 
taken  by  the  needed  innovations,  the  methods  of  their 
introduction,  and  the  additional  cost  thereby  entailed, 
President  Roosevelt  appointed,  about  the  middle  of  1905, 
a  committee  of  executive  officers,  which  was  officially 
known  as  the  "Committee  on  Department  Methods." 
Through  the  direct  efforts  of  this  organization,  which 
associated  with  itself  a  large  number  of  sub-committees 
comprising  in  all  some  seventy  different  subordinate  of- 
ficers of  the  Government,  a  general  overhauling  of  public 
business  methods  was  undertaken.  The  changes  proposed 
by  the  committee,  and  actually  introduced  upon  its  sug- 
gestions, included  matters  of  internal  organization,  depart- 
mental relations,  modes  of  purchasing  and  contracting,  and 
many  others.  A  complete  account  of  the  alterations  in 
business  methods  thus  brought  about  would  require  an 
elaborate  treatment.  It  is  proposed  here  merely  to  sug- 
gest some  of  the  typical  changes  in  modes  of  accounting 
which  have  been  produced  largely  as  a  result  of  the  in- 
vestigations of  the  committee.  It  is  not  true  in  all  cases 
that  the  new  methods  now  employed  were  directly  adopted 
at  the  instance  of  this  committee,  but  it  may  fairly  be 
said  that  in  the  majority  of  cases  they  were  a  result  of 
the  general  movement  of  which  the  labors  of  the  committee 
constituted  the  most  striking  feature.  All  that  will  be 
attempted  in  the  present  review  is  to  select  a  representative 
example  of  each  of  the  important  classes  of  changes  that 
have  been  introduced  largely  imder  the  influence  or  inspi- 
ration of  the  committee,  and  to  explain  it  as  illustrative 


CHANGES  IN  GOVERNMENT  ACCOUNTING  317 

of  tHe  new  point  of  view  which  has  been  adopted  by  the 
administration. 

Treasury  Accounting. 

Although  not  the  earliest  in  point  of  time,  the  most 
important  suggestion  made  by  the  committee  relates  to 
the  accounting  system  of  the  Treasury  Department.  The 
Treasury  has  always  pursued  an  efficient  system  of  ac- 
counting, but  its  results  have  been  such  as  required  much 
explanation  as  well  as  intimate  acquaintanceship  with  the 
methods  pursued  in  the  other  departments.  Briefly  sum- 
marized, the  plan  of  accounting  followed  by  the  Treasury 
prior  to  1907  was  as  follows: 

^v  *rour  classes  of  warrants  were  recognized  by  the  de- 
partment, and  all  moneys  covered  into  or  paid  out  of  the 
Treasury  were  (and  are)  required  to  be  covered  or  paid 
upon  the  appropriate  one.  The  four  classes  of  warrants 
were  appropriation  warrants  (issued  for  the  purpose  of 
crediting  appropriation  accounts  with  funds);  pay  war- 
rants (authorizing  the  Treasurer  of  the  United  States  to 
pay  out  funds  either  later  to  be  accounted  for  by  disburs- 
ing officers  or  else  for  the  purpose  of  settling  amounts 
due  by  the  United  States  to  creditors) ;  covering  warrants 
(authorizing  the  Treasurer  to  take  up  in  his  general  ac- 
counts deposited  revenues  or  funds  held  by  disbursing 
officers  and  re-deposited  in  the  Treasury);  and  transfer 
and  counter  warrants  (issued  for  the  purpose  of  charg- 
ing one  appropriation  and  crediting  another  in  order  to 
bring  about  an  adjustment).  With  this  legal  basis,  the 
division  of  bookkeeping  and  warrants  in  the  Treasury  was 
in  the  habit  of  keeping  registers  of  revenue  warrants, 

*  A  complete  official  account  of  treasury  methods  of  accounting  is  found 
in  the  document  entitled  "Information  Relating  to  the  Accounting  System  of 
the  United  States  Treasury  Department/'  compiled  by  Robert  S.  Person,  and 
published  by  the  Government  Printing  Office  in  May,  1905.  The  report  on 
■which  the  recent  changes  have  been  based  was  issued  for  private  circulation 
by  the  Committee  on  Department  Methods  as  a  "Report  to  the  President  by 
the  Committee  on  Department  Methods.  Treasury  Bookkeeping."  January 
19,  1907. 


318  HENRY  PARKER  WILLIS 

registers  of  paid  warrants,  and  registers  of  re-pay  war- 
rants. Appropriation  warrants  were  never  registered,  but 
were  themselves  bound  after  being  posted.  Appropria- 
tion ledgers  were  kept,  and  also  personal  ledgers  relating 
to  collecting  officers,  disbursing  officers  and  special  ac- 
counts. The  appropriation  ledgers  were  posted  from  reg- 
isters of  warrants,  while  personal  ledgers  were  posted 
either  from  warrants  of  the  kinds  specified  or  from  audi- 
tors' certificates. 

From  this  review  it  is  seen  that  the  result  of  the  books 
was  merely  a  classification  of  gross  revenue  collections 
and  of  gross  warrant  withdrawals.  No  trial  balance  would 
be  possible,  and  blunders  could  be  detected  only  through 
careful  work  by  auditors  and  the  clerks  in  the  Treasury 
Department.  The  defect  of  the  system  was  the  inability  to 
prove  the  correctness  of  the  accounting  at  any  given  time, 
and  also  the  difficulty  of  exhibiting  in  convenient  form  the 
precise  status  of  each  appropriation  as  well  as  of  the  bal- 
ances in  the  accounts  of  officers  of  the  United  States. 

As  a  central  necessity  in  the  reorganization  of  treasury 
bookkeeping,  the  Committee  on  Department  Methods 
recommended  the  introduction  of  a  comprehensive  system 
of  double  entry.  The  problem  was  to  provide  a  debit  and 
credit  side  for  all  accounts,  including  revenues  and  ex- 
penditures. The  change  implied  the  introduction  of  fi,ve 
new  books  not  previously  kept  by  the  department,  viz., 
the  general  ledger,  the  journal,  the  ledger  of  revenues,  the 
ledger  of  expenditures,  and  the  register  of  auditors'  certifi- 
cates— the  first  two  books  to  be  written  up  only  once  a 
month.  A  form  of  journal  voucher  embracing  the  entire 
transactions  was  recommended,  these  vouchers  to  be 
spread  upon  the  journal  after  being  certified  and  approved. 
The  journal  was  to  be  posted  to  the  general  ledger  pro- 
viding general  accounts  with  the  Treasurer  of  the  United 
States,  collecting  and  disbursing  officers,  with  individuals 
and  firms  with  whom  business  was  done,  witK  revenueig 


CHANGES  IN  GOVERNMENT  ACCOUNTING  319 

by  five  general  classes  (customs,  postal,  internal  revenue, 
sales  of  public  lands,  and  miscellaneous),  with  appropria- 
tions, with  expenditures,  with  warrants,  deposits  and  with- 
drawals, and  with  other  proper  accounts.  It  was  argued 
that  these  innovations  would  enable  the  status  of  each  ac- 
count in  the  aggregate  to  be  determined  in  advance,  would 
insure  correct  details,  would  compel  a  balance  of  all  ac- 
counts, and  would  anticipate  detailed  balances  of  the  sev- 
eral accounts,  and  compel  their  correctness,  while  requir- 
ing consistent  and  comprehensive  statements  of  items  en- 
tered in  auditors'  certificates.  At  the  end  of  the  year  it 
would  show  the  status  of  all  the  accounts,  the  opening 
balainces  of  all  accounts,  the  revenues,  the  expenditures, 
the  miscellaneous  transactions  incident  thereto,  and  the 
final  balances  in  all  accounts.  The  plan  was  approved  by 
a  select  committee  of  public  accountants  appointed  by  The 
American  Association  of  Public  Accountants,  and  was  or- 
dered put  into  operation. 

In  a  final  order  issued  July  14,  1908,  specified  defini- 
tions of  general  accoimts  were  ordered  to  be  observed  sub- 
sequent to  that  date,  and  all  certificates  of  settlement  of 
accounts  thereafter  were  to  be  made  and  declared  on  a 
similar  basis.  Under  the  head  of  general  accounts,  six 
general  classes  were  recognized.  The  first  included  five 
general  accounts — customs  revenue,  postal  revenue,  inter- 
nal revenue,  public  lands,  and  miscellaneous  revenue.  The 
second  and  third  general  classes  of  expenditures  included 
four  general  accounts — expenditures  excluding  reductions 
of  public  debt,  the  return  of  trust  funds,  etc.,  the  public 
debt  (payments  of  interest,  however,  being  charged  not  to 
this  account,  but  to  that  of  expendituresj,  special  funds, 
disbursements  from  which  were  to  be  charged  to  expendi- 
tures, and  trust  funds,  to  be  credited  with  receipts  of  trust 
funds,  and  charged  with  disbursements  from  trust  funds. 
The  fourth  general  class  included  personal  accounts — those 
with  the  Treasurer  of  the  United  States,  those  with  fiscal 


P20  HENRY  PARKER  WILLIS 

officers,  and  those  with  the  District  of  Columbia.  Class 
five  included  so-called  '^ record  accounts,"  these  being  two 
in  number — appropriations,  and  available  funds.  Class  six 
consisted  of  clearing  accounts,  and  included  treasury  de- 
posits, charged  with  items  certified  for  credit  to  fiscal  offi- 
cers, accountable  warrants,  settlement  warrants,  warrants 
account,  transfer  of  funds,  advances  to  fiscal  officers,  and 
credits  of  fiscal  officers.  To  these  general  accounts  there 
was  added  a  special  class  of  accounts  entitled  balances, 
being  a  continuation  of  the  former  balance  account,  and 
including  with  each  year  the  balances  of  the  preceding 
year's  accounts  of  audited  revenues  and  expenditures.  To 
this  account  would  be  charged  the  additional  credit  bal- 
ances and  credited  the  additional  debit  balances  in  fiscal 
accounts  brought  into  the  books  of  the  current  year.  It 
was  further  ordered  that  the  division  of  bookkeeping  and 
warrants  should  not  keep  separate  accounts  with  collect- 
ing and  disbursing  officers  by  appropriations,  but  should 
keep  separate  accounts  with  officers,  corresponding  to  the 
accounts  required  to  be  rendered  by  them  to  the  several 
auditors  of  the  Treasury  Department.  In  calling  for  the 
bookkeeper's  certificate  of  balances  due  from  collecting 
and  disbursing  officers  and  other  depositors,  it  was  direct- 
ed that  the  auditor  should  indicate  the  period  covered  by 
the  account  about  to  be  settled,  and  request  a  certificate 
from  the  division  of  bookkeeping  and  warrants  of  charges 
and  credits  covering  that  period  only. 

Disbursing  Officers*  Vouchers  and  Balances. 

An  important  change  in  the  methods  of  treasury  ac- 
counting formerly  in  use  has  further  been  made  in  connec- 
tion with  disbursing  officers'  checks  and  vouchers,  and 
the  verification  of  disbursing  officers'  balances.*    Under 


*The  recommendations  to  the  President  on  this  topic  made  by  the  Com- 
mittee on  Department  Methods  are  found  in  the  "Report  to  the  President  of 
the  Committee  on  Pepartment  Methods";  Assembling  Disbursing  Officers' 


CHANGES  IN  GOVERNMENT  ACCOUNTING  321 

tlie  system  in  vogue  prior  to  1907  the  expenses  of  govern- 
ment were  paid  by  either  of  two  methods:  (1)  A  treas- 
ury warrant  was  issued,  upon  an  auditor's  certificate,  in 
favor  of  the  public  creditor.  This  method  of  payment  was 
commonly  known  as  a  direct  settlement.  (2)  Disbursing 
officers  who  had  received  advances  from  the  Treasury  paid 
public  creditors  (usually  by  check)  and  took  a  receipt, 
which  became  the  voucher  on  the  basis  of  which  the  dis- 
bursing officer  claimed  credit  in  rendering  his  accounts  to 
the  auditor.  Of  the  two  the  system  of  paying  through 
disbursing  officers  covered  far  the  larger  part  of  the  ex- 
penses of  the  Government. 

Investigation  showed  that  disbursing  officers  were  in 
the  habit  of  securing  receipts  from  public  creditors  in  ad- 
vance of  payment,  the  creditors  frequently  signing  re- 
ceipts in  blank,  leaving  the  dates  and  amount  to  be  filled 
in  as  occasion  required.  Duplicate  vouchers,  and  in  some 
cases  triplicate  or  even  quintuplicate  vouchers,  were  se- 
cured by  the  disbursing  officers  and  offered  a  correspond- 
ing opportunity  for  fraud.  Whenever  a  disbursing  officer 
stated  his  account  to  the  appropriate  auditor  and  acknowl- 
edged a  certain  balance  due  to  the  United  States  nothing 
was  done  by  the  auditor  to  verify  that  statement.  In  many 
cases  disbursing  officers  have  been  short  in  their  accounts 
for  years,  acknowledging  a  given  amount  to  be  due  the 
United  States,  when  as  a  matter  of  fact  they  did  not  have 
the  acknowledged  amount  in  hand.  Various  efforts  to  cor- 
rect the  situation  have  been  unsuccessful.  In  looking 
over  the  conditions,  the  Committee  on  Department  Meth- 
ods recommended  that  the  receipt  habitually  taken  in  ad- 
vance should  be  abolished,  and  that  in  place  of  it  should 
be  provided  a  form  of  certificate  to  be  signed  by  the  claim- 
ant. The  claimant's  certificate  was  to  be  followed  by  the 
certificate  of  the  proper  administrative  officer  approving 

Checks-  and  Vouchers,  and  Verification  of  Disbursing  Officers'  Balance?;.  The 
order  putting  these  recommendations  into  efifect  was  issued  as  Department 
Circular  No.  52,  July  29,  1907. 

B— VIII— 2X 


322  HENRY  PARKER  WILLIS 

the  claim,  while  the  check  to  be  delivered  in  paying  the 
account  in  question  should  state  upon  its  face  the  object 
for  which  dra^^m,  and  also  the  number  of  the  voucher  in 
payment  of  which  it  was  drawn.  It  was  recommended 
further  that  assistant  treasurers  and  national-bank  de- 
positaries should  render  monthly  statements  just  as  for- 
merly to  each  disbursing  officer  having  funds  on  deposit 
with  them,  but  should  at  the  same  time  send  to  the  Treas- 
ury  Department  for  distribution  to  the  proper  auditors 
duplicates  of  the  statements  sent  to  the  disbursing  officer, 
accompanied  by  such  officer's  paid  check  listed  in  the  state- 
ments. The  auditor  would  thus  have  the  means  of  check- 
ing up  each  statement,  and  ascertaining  accurately  whether 
or  not  a  given  disbursing  officer  had  in  his  hands  or  on 
deposit  to  his  official  credit  and  not  covered  by  outstand- 
ing checks,  the  amount  of  his  stated  balance.  In  order  to 
test  the  proposed  scheme,  experiments  were  undertaken, 
and  from  these  it  was  concluded  that  the  new  system,  be- 
sides its  technical  advantages,  would  be  comparatively 
cheap,  involving  an  additional  outlay  of  probably  not  more 
than  six  per  cent  of  the  existing  work  of  the  accounting 
officers.  Working  on  the  basis  of  these  suggestions,  the 
Secretary  of  the  Treasury  issued  an  order  introducing  sub- 
stantially the  system  recommended  by  the  committee  which 
is  now  in  practical  operation. 

In  putting  the  new  system  into  effect  there  has  naturally 
been  some  necessity  for  innovation,  retraining  of  clerks, 
and  adjustment  of  old  methods  to  new.  This  process  has 
not  been  without  its  friction,  and  some  of  the  older  officers 
of  the  department  have  been  inclined  to  question  the  wis- 
dom of  adopting  the  double  entry  system  with  its  greater 
amount  of  detail  and  labor.  Thus  the  auditor  of  the  Navy 
Department  in  reporting  for  the  year  1908  states  flatly 
as  the  reason  why  his  office  fell  seriously  behind  in  its 
work  during  the  year,  the  considerable  amount  of  "extra 
work"  necessitated  by  the  new  system,  and  the  labor  in- 


CHANGES  IN  GOVERNMENT  ACCOUNTING  323 

volved  in  training  the  clerks  to  follow  the  system.  Time 
has  not  yet  been  allowed  for  a  thorough  and  complete  test 
of  the  efficiency  of  the  new  method,  nor  is  it  absolutely 
certain  whether  the  greater  convenience  and  certainty 
attained  under  the  new  plan  will  make  up  fully  for  the 
greater  labor  and  costliness  involved  in  the  additional 
bookkeeping  operations  which  have  been  necessitated. 
That  the  plan  is  a  substantial  improvement  from  the  ac- 
countant's standpoint  there  can  be  no  question,  while  the 
publication  of  more  and  clearer  details  with  reference  to 
government  fiscal  operations  will  be  made  practicable 
under  it. 

Introduction  of  Cost  Accounting. 

An  Important  aspect  of  the  new  movement  for  better 
business  methods  in  the  public  service  is  seen  in  the  recent 
effort  to  put  the  various  manufacturing  activities  which 
the  Government  conducts  upon  somewhat  the  same  plane 
that  is  occupied  by  similar  undertakings  in  private  hands. 
By  this  is  not  meant  that  there  has  been  any  effort  to 
introduce  a  lower  standard  of  payment  or  to  reduce  wages 
paid  by  the  Government  to  commercial  standards.  On  the 
contrary,  the  work  of  the  Committee  on  Department  Meth- 
ods, as  well  as  that  of  the  systematizers  and  reorganizers 
of  the  Government  generally,  has  recognized  a  high  stand- 
ard of  payment  with  due  recognition  of  the  older  workers 
as  a  necessary  feature  of  the  public  service,  and  as  a  de- 
sirable part  of  the  Government's  duty  in  upholding  a  suit- 
able example  for  private  employers  to  work  toward  so  far 
as  competitive  conditions  permit.  What  has  been  sought 
is  an  understanding  of  the  actual  use  made  of  public 
moneys,  and  more  careful  analysis  of  the  ways  in  which 
they  have  been  expended,  with  a  corresponding  analysis 
of  the  results  accruing  from  such  outlay.  The  public  enter- 
prise which  most  nearly  approaches  a  commercial  type  of 
organization  at  the  present  time  is  the  Government  Print- 


g24  HENRY  PARKER  WILLIS 

ing  Office,  an  establishment  toward  whose  systematization 
various  officials  have  for  years  been  struggling  without 
result. 

Government  Printing  Costs.* 

The  great  problem  of  the  Government  Printing  Office 
for  many  years  past  has  been  that  of  ascertaining  costs 
sufficiently  accurately  to  permit  of  correct  charges  to  the 
several  departments  on  a  basis  that  would  allow  the  office 
to  come  out  clear  and  without  a  deficit  at  the  end  of  the 
year.  That  the  officials  have  found  it  impossible  to  attain 
this  end  may  be  seen  from  a  tabulation  prepared  during 
certain  inquiries  at  the  Government  Printing  Office  directed 
by  President  Eoosevelt,  which  exhibits  the  resources  or 
appropriations,  disbursements,  unexpended  balances,  sales, 
and  disbursements  in  excess  of  sales  over  a  period  of  years. 
From  this  it  is  seen  that  the  disbursements  in  excess  of 
sales  during  the  years  1900-1907  inclusive,  amounted  to 
$7,962,307.  During  the  same  period  expenditures  for  plant 
properly  chargeable  to  the  years  in  question  approximated 
$3,100,000.  A  difference  of  about  $5,000,000,  therefore,  rep- 
resents the  discrepancy  between  actual  receipts  for  the 
coromercial  services  of  the  institution  and  outlays  for  carry- 
ing it  on.f  In  fact,  since  1900,  Congress  has  been  incurring 
an  expenditure  of  about  $600,000  a  year  over  and  above 
the  income  earned  by  the  office.  The  conclusion  that  a 
system  of  cost  accounting  was  needed  which  would  place 
the  charges  for  printing  upon  the  different  departments 
to  which  they  properly  belonged,  was  therefore  irresistible. 

An  investigation  into  conditions  in  the  printing  office 
by  the  Committee  on  Department  Methods  was  originally 


*  For  information  with  reference  to  the  system  of  accounting  and  cost 
keeping  in  the  Government  Printing  Office  I  am  indebted  to  Hon.  John  S. 
Leech,  late  Public  Printer,  and  to  his  associates  in  the  work  of  the  office, 
especially  to  Mr.  Vipond,  the  head  of  the  Accounting  Division,  and  Mr.  Ken- 
dal, the  Assistant  Superintendent  of  Work. 

'  t  Hon.   W.    S.    Rossiter    made    a    complete    investigation    of    the    office   by 
direction  of  the  President,  and  the  above  data,  are  taken  from  his  report. 


CHANGES  IN  GOVERNMENT  ACCOUNTING  325 


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926  HENRY  PARKER  WILLIS 

directed  by  President  Roosevelt  for  the  purpose  of  secur- 
ing information  as  to  certain  contracts  and  methods  about 
which  doubt  was  felt.  Tliis  investigation  broadened  into 
an  inquiry  into  the  cost  of  public  printing  and  the  possible 
lines  of  economy.  It  was  about  the  time  of  this  secondary 
investigation  that  Public  Printer  Palmer  resigned  and  was 
followed  by  Charles  A.  Stillings.  The  new  public  •printer 
was  disposed  to  give  due  weight  to  the  suggestions  which 
had  been  made  by  the  Committee  on  Department  Methods, 
and  among  others  he  found  the  following,  which  had  been 
laid  before  President  Roosevelt  in  a  report  made  Janu- 
ary 2, 1906: 

There  should  be  established  in  the  Government  Printing  Office  a  proper 
system  of  cost  keeping.  There  is  not,  and  never  has  been  a  system  of  cost 
keeping  in  that  establishment.  The  charges  made  against  the  various  depart- 
ments for  work  ordered  to  be  paid  for  out  of  the  department  allotments  for 
printing  do  not  accurately  reflect  the  cost  of  the  work.  ._  .  .  An  accurate 
system  of  cost  keeping  .  .  .  would  .  .  .  also  permit  the  cost  of  work 
in  the  printing  office  to  be  better  compared  with  that  of  private  establish- 
ments. It  would  enable  standards  of  cost  for  the  solid,  tabular,  and  other 
kinds  of  work  to  be  established.  It  would  also  disclose  the  actual  saving  from 
the  adoption  of  new  devices  and  machinery  and  whether  the  results  obtained 
equal  those  obtained  by  others  using  the  same  devices.  In  the  institutionof 
such  a  cost-keeping  system  in  the  printing  office  the  service  of  an  outside 
expert  could  be  profitably  used.  ...  The  establishment  of  a  cost  keeping 
system  in  a  large  printing  establishment  is  a  complicated  rnatter,  and  the  use 
of  a  specialist  in  instituting  an  accurate  system  is  almost  indispensable. 

Acting  upon  this  suggestion,  the  public  printer  intro- 
duced, so  soon  as  he  was  able  to  obtain  the  requisite  appro- 
priations from  Congress,  a  cost-keeping  plan  known  as  the 
**  audit  system. '^  This  was  established  by  a  New  York  firm 
at  a  total  cost  for  the  system  itself  and  the  supplies  needed 
under  it  of  about  $130,000.  Inasmuch  as  the  cost  of  public 
printing  did  not  decrease,  but  was  added  to  by  the  unusu- 
ally large  cost  of  the  new  system  of  accounting,  the  innova- 
tion made  by  Mr.  Stillings  did  not  meet  with  approval. 
A  special  investigator,  directed  by  President  Roosevelt 
to  look  into  the  situation  in  the  office,  terminated  the  con- 
tract with  the  firm  which  had  established  the  **  audit  sys- 
tem," and  largely  curtailed  the  operations  involved  in  the 
ieost-keeping  plan.    Reporting  upon  the  system,  which  will 


CHANGES  IN  GOVERNMENT  ACCOUNTING  327 

not  be  reviewed  here  because  of  its  practical  elimination, 
this  investigator  said: 

It    ...    is    principally   to   be   criticised    upon   the   score   that   in    an 

attempt  to  secure  all  classes  of  detail,  the  amount  of  labor  entailed  upon 
each  employe  for  the  purpose  of  recording  necessary  facts,  and  the  amount 
of  labor  required  for  subsequent  tabulation  were  so  great  as  to  make  the 
system  almost  prohibitive. 

Subsequent  to  assuming  office,  June,  1908,  Hon.  Jobn 
S.  Leech,  who  succeeded  Mr.  Stillings  in  the  control  of 
the  Government  Printing  Office,  undertook  a  complete  re- 
organization of  the  system  of  cost  accounting  which  had 
been  introduced,  recognizing  it  as  most  desirable  that  such 
a  system  be  applied  to  the  work  of  the  office,  though  he 
did  not  approve  of  the  plans  that  had  been  attempted  by 
his  predecessor  under  the  advice  of  the  f  ramers  of  the  audit 
system.    Mr.  Leech's  methods  of  cost  accounting  were  of 
exceptional  interest,  because  they  had  been  worked  out 
by  himself  as  a  result  of  many  years'  experience,  first  in 
the  Government  Printing  Office  at  Washington,  and  later 
as  public  printer  in  the  Philippines,  where  he  was  in  charge 
of  the  printing  establishment  of  the  Philippine  Commission. 
The  main  ideas  accepted  by  Mr.  Leech  as  the  founda- 
tion of  his  cost  system  are  two  in  number: 
(IJ  The  adoption  of  appropriate  systems  of  measuring  cost 
in  each  productive  operation,  without  any  effort  to 
pursue  an  absolutely  uniform  system  of  measurement 
for  all  operations. 
[(2J   The  abandonment  of  the  idea  of  apportioning  indi- 
vidual costs  to  particular  pieces  of  work,  and  the  sub- 
stitution in  lieu  thereof  of  a  fixed  scale  of  uniform 
charges  which  is  applied  to  each  job  whose  perform- 
ance is  proposed.    The  results  of  the  cost-accounting 
system  are  employed  solely  for  the  purpose  of  vary- 
ing this  scale  of  charges  in  order  to  approximate  it 
as  nearly  as  possible  to  average  cost.  j 

The  problem  before  the  Government  Printing  Office 
differs  from  that  presented  in  a  commercial  establishment 


g28  HENRY  PARKER  WILLIS 

in  some  particulars.  The  office  is  provided  with  a  com- 
plete and  costly  plant  situated  in  a  government  building. 
No  effort  is  made  to  allow  for  interest  on  the  capital  in- 
volved in  this  building  or  in  the  original  establishment 
of  the  plant  which  it  contains.  These  are  regarded  as  given 
quantities.  What  the  office  seeks  to  do  is  to  find  out  how 
much  is  being  spent  upon  the  repair  and  maintenance  of 
machinery  and  tools  that  are  worn  out,  upon  the  acquisi- 
tion of  new  supplies  and  stores,  and  upon  the  purchase 
of  labor  from  week  to  week.  It  then  endeavors  to  appor- 
tion these  costs  to  the  various  divisions  in  which  they  are 
incurred.  Before  going  into  the  strictly  cost  accounting 
features  of  the  work,  it  is  worth  while  to  devote  some  at- 
tention to  certain  more  general  aspects  of  Government 
Printing  Office  accounting. 

Beginning  before  the  actual  entry  of  supplies  into  the 
office,  a  system  has  been  devised  for  keeping  account  of 
orders.  This  is  known  as  the  ''order  record."  In  it  are 
compiled  all  purchase  orders  after  the  same  have  been 
made  up  and  approved  in  due  form.  These  puj'chase 
orders  are  recorded  upon  one  side  of  the  book,  while  upon 
the  opposite  side  in  similarly  headed  columns  are  recorded 
the  quantities  of  goods  actually  received  in  response  to 
the  orders  that  have  been  sent  out  to  private  contractors 
from  whom  the  goods  are  bought.  When  goods  enter  the 
Government  Printing  Office  they  are  examined,  and  a  so- 
called  ''receiving  ticket"  is  made  out  and  certified  by  the 
storekeeper  and  by  a  board  of  inspection.  These  tickets 
constitute  the  source  from  which  the  receiving  side  of  the 
order  book  is  posted,  just  as  the  purchase  orders  furnish 
the  raw  material  from  which  the  purchase  side  or  order 
is  made  up.  It  frequently  happens  that  a  given  consign- 
ment contains  more  or  less  than  the  precise  amount  that 
has  been  ordered.  In  that  event  the  amount  actually  re- 
ceived is  recorded,  and  in  a  subordinate  book  provision 
js  made  for  a  separate  account  with  "overs"  and  "unders" 


CHANGES  IN  GOVERNMENT  ACCOUNTING   329 


Jacket  made  up  by 

Date 

Index 

L'ept.  Ordering 


.  Osrrections  by  _ 

COVCRNMENT   PRIHTIHC  OFFICE 

JACKET  INFORMATION  SUP 


Jacket  No. 
Req.  No. 


PREVIOUS  JACKET  NOS. 


Authority 


No.  Authorized 


QUANTITY 


Form  No. 


BINDING   MEMO. 


Proof. 

Deliver  Proof  to_ 


COMPOSITION   _. 


Type  Measure 
Rule  


Run  from  Type  

Keep  Standing  . 


Electrotypes 


Stereotypes 


Illustrations 
Maps 


Div. Req.  No. 

Half-tones Text  Figs.  _ 


BINDERY  OPERATIONS 


PRESSWORK 


pDITION 
No. 
Size  - 


Ueav 
J  Page 


No.  Sigs. 


Ink 


No.  of  Pages  . 
Sig.  Mark  __ 
Numbering  _ 
Cover  


No.  of  Forms  . 


Folding 

Gumming  or  Tipping  . 

Gathering  

Sewed 


Interleaving 

Pasting 

Collating 

Cased 


Style  of  Bmding  , 


Perforating  . 


Canvas  Covers . 


REAMS   SHEETS 


COLOR  KIND  OF  PAPER  SIZE  WT 


Lettered  on  Side 


Lettered  on  Back 


Gold,  Aluminum,  or  Ink  

Head  Band Guards Lining  Paper  _ 

Stamping  Edging Waste  Papers. 


Paging  — 

Ruling 

Punching 
Tablets  _ 
Pads 


Indexing 

Numbering  . 
Perforating  . 
Eyeleting  _ 
Tagging 


Size 

Cutting  

Wrapped- 
Deliver  to  , 


Composing  and  Proof  Reading  Section . 


Counting 


Work  will  be  per-    F°""dry 
formed    on    this    p^^j  Room . 
Jacket  in- 

I  Folding  Room  . 

,  Bindery  . 


Figure  2 


330 


HENRY  PARKER  WILLIS 


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CHANGES  IN  GOVERNMENT  ACCOUNTING  331 

in  order  that  it  may  be  possible  at  all  times  to  know  the 
precise  relation  between  gross  orders  and  gross  receipts 
and  their  value.  By  posting  the  separate  accounts  in  this 
way  and  carrying  down  the  totals,  it  is  possible  at  any 
moment  to  ascertain  the  obligations  of  the  office  accurately. 
In  paying  for  goods  ordered,  vouchers  are  made  up  after 
each  order  record  has  been  audited  and  completed.  This 
voucher  is  then  sent  to  the  private  contractor  and  is  certi- 
fied by  him,  after  which  it  is  returned  to  Washington, 
where  it  is  signed,  and  a  check  is  made  out  and  sent  to 
the  public  printer  for  his  signature.-  A  voucher  register 
is  kept,  and  in  this  all  such  vouchers  are  recorded.  From 
it  direct  postings  are  made  to  the  purchasing  ledger.  What 
amounts  to  a  cash  book  is  kept  as  a  so-called  *' disburse- 
ment book."  After  the  checks  are  drawn  in  payment  for 
supplies  they  are  duly  entered  in  this  book.  The  same 
is  done  with  the  results  of  pay-rolls,  and  the  postings  are 
then  made  to  the  ^Hreasury  ledger"  under  the  respective 
appropriation  headings  which  have  been  followed  by  Con- 
gress in  assigning  money  for  the  Government  Printing 
Office,  as  for  example,  *  Sprinting  and  binding,  1908."  This 
assigns  the  disbursements  of  a  given  period  to  the  appro- 
priation upon  which  they  constitute  a  draft.  In  account- 
ing with  employes,  pay-rolls  are  made  up  in  the  following 
manner:  A  daily  time  slip  is  turned  in  from  each  of  the 
*' sections"  and  ^'branch  offices"  into  which  the  different 
divisions  of  the  printing  office  are  sub-classified.  The  total 
number  of  such  sections  or  branch  offices  is  about  fifty. 
In  each  case  the  time  slip  is  certified  by  the  man  in  charge 
of  the  section  in  which  it  originates.  When  these  slips 
have  been  received  by  the  accounting  division  they  are 
transferred  to  a  time  roll,  upon  which  are  shown  the 
amounts  due  to  each  employe  over  a  period  of  two  weeks 
for  work  done  and  for  annual  leave  which  he  has  chosen 
to  take  during  that  period.  At  the  end  of  two  weeks,  the 
suitable  amount,  based  upon  the  employe's  time  is  paid 


332  HENRY  PARKER  WILLIS 

to  him  in  enrrency,  and  lie  personally  signs  the  pay-roll 
Indicating  that  he  has  received  the  amount.  The  only 
distinction  recognized  in  grouping  the  payments  on  pay- 
roll account  is  that  between  *  Sprinting  and  binding"  and 
''annual  leave,"  actual  work  being  paid  for  out  of  the  first, 
and  "time  off,"  up  to  the  amount  annually  allowed,  out 
of  the  latter.  At  the  end  of  each  month  both  pay-rolls  and 
vouchers  are  sent  to  the  Treasury,  and  are  there  audited 
and  filed. 

In  keeping  account  with  property  the  main  reliance  is 
placed  upon  a  system  of  card  records,  on  which  are  shown 
the  amounts  of  each  class  of  supplies  received  by  the  office 
and  by  it  issued  upon  suitable  requisition  to  the  several 
divisions  or  sections.     Orders  for  supplies  are  sent  out 
as  a  result  of  a  "  Stores  Alarm  Slip. ' '    This  so-called  ' '  slip ' ' 
is  herewith  reproduced,  (Figures  1  and  la).    It  may  origi- 
nate anywhere  in  the  printing  office,  but  must  be  approved 
or  disapproved  by  the  immediate  superior  of  the  employe 
in  charge  of  any  division  or  section  in  which  it  starts. 
Whenever  the  stock  of  an  article  on  hand  has  been  reduced 
to  the  maximum  point  representing  the  amount  that  will 
be  required  until  a  new  supply  can  be  obtained,  or  when- 
ever a  new  article  is  wanted,  the  alarm  slip  is  to  be  started. 
This  slip  after  being  duly  approved  exhibits  the  descrip- 
tion of  the  article,  the  quantity  wanted,  the  quantity  on 
hand,  and  a  number  of  other  items  of  information.    It  also 
provides  for  specifications  which  are  to  be  written  in,  and 
gives  instructions  as  to  the  way  in  which  purchases  are 
to  be  made.    Wlien  the  supplies  have  been  received  and 
duly  approved  by  the  officials  who  make  up  the  ticket,  the 
amount  of  the  supplies  thus  in  hand  is  recorded  on  the 
cards  to  which  reference  has  already  been  made.     Simi- 
larly, when  stores  are  issued,  the  amount  issued  from  each 
consignment  of  goods  is  recorded  upon  the  back  of  the  card 
relating  to  that  consignment  at  the  price  per  imit  which 
was  paid  when  the  goods  were  purchased.    In  this  way  a 


CHANGES  IN  GOVERNMENT  ACCOUNTING  333 

continuoiTS  inventory  is  kept,  showing  the  quantities  of 
each  class  of  supplies  on  hand,  and  this  is  checked  from 
time  to  time  from  an  actual  inventory  taken  in  the  stores 
division. 

The  office  carries  a  combined  record  of  supplies  issued 
in  a  so-called  ^' issue  book."  Entries  in  this  book  are  made 
from  slips  which  constitute  orders  upon  the  storekeeper 
for  supplies.  By  posting  the  issue  book  from  the  slips  in 
question  it  can  be  seen  exactly  what  stores  have  been  called 
for  and  have  been  furnished  after  approval  of  the  requi- 
sition to  each  division.  This  gives  a  compiled  comparative 
statement  of  the  amount  of  stores  issued  to  each  section 
of  the  office,  classified  under  headings  showing  how  they 
have  entered  into  product  maintenance,  etc. 

The  subject  of  cost  accounting  in  the  Government  Print- 
ing Office  can  best  be  approached  by  considering  the  way 
in  which  goods  are  ordered  by  the  several  executive  de- 
partments, and  estimates  made  in  response.  Supposing 
that  a  given  bureau  or  department  has  a  specified  piece 
of  work  which  it  is  desired  to  have  done,  it  may  fill  out 
a  blank  requesting  information  from  the  printing  office 
with  reference  to  the  cost.  At  the  office  a  so-called  "esti- 
mate for  printing  and  binding"  is  then  made  up,  which  is 
practically  a  bid  on  the  work.  This  slip  affords  detailed 
data  concerning  the  cost  of  paper  used,  the  amount  needed, 
the  cost  of  the  various  bindery  operations,  the  cost  of  com- 
position and  press  work,  and  so  forth.  These  items  of 
information  are  supplied  by  the  experts  of  the  office 
through  consideration  of  the  job  in  comparison  with  the 
fixed  scale  of  charges  of  the  office  which  has  been  prepared 
for  the  guidance  of  the  experts  in  just  such  cases.  Sup- 
posing that  the  estimate  is  satisfactory  to  the  department 
which  ordered  the  estimate  made,  the  printing  office  is 
directed  to  proceed,  and  the  appropriate  instructions  are 
given.*  In  the  course  of  the  operation  a  so-called  "jacket 
information  slip"  is  worked  out.    This  jacket  information 


334 


HENRY  PARKER  WILLIS 


form  Ko.  B  sa^ 


ABSTRACT  OF  STORES  ALARM  SLIP. 


Division   Alarm   No.. 
Date  . 


Quantity  and  article 


-.  190_ 


THE  TIME  DECEIVED  SH.\Ll,  BE  STAMPED   IN'  EACH  DIVISIO:<. 


NO. 


Government  Printing  Office 


STORES  ALARM    SLIP. 

THE  BASIS   FOU   MAKINCi   ALL  PUItCIlASIi.s   EXCEPT  ILLU.STRATION'.'i. 


This  Alarm  Slip  must  not  be  destroyed  or  pigejn-holed.  a.id  when  once  itarted  must  reach  its  destination.    READ  INSTRUCTIONS  ON  OTHER  SIDE. 


This  Alarm  Slip  may  be  started  by  any  omclal  or  employee  In  charge  or  any  division  or  section,  but  must  lie  approved  or 
disapproved  by  his  Immediate  superior;  and  before  being  forwarded  must  receive  the  approval  or  dwappro^'r>l  of  ilie  foreman  of 
the  division  which  pertains. 

Wlienever  the  stock  on  hand  of  an  article  has  been  reduced  to  the  mavlraum  point  to  last  until  a  new  supply  c.in  be  obt.ilncdt 
or  If  a  new  article  Is  wanted,  this  Alarm  Slip  Is  to  be  started.  When  Issuing  supplies  the  Storekeeper  should  remind  I  lie  IToperty 
Clerk  by  memorandum  that  supply  Is  down  to  ordering  point,  or  v^ice  versa. 

II  In  the  opinion  of  the  Purchasing  Agent  the  article  called  for  on  this  Alarm  .Slip  can  In  any  way  be  clinn£;ed  lo  iltc  ndvan* 
tage  of  the  service,  he  shall  at  once  bring  the  matter  to  the  attention  of  the  Public  Printer  by  memorandum  uiiaciird  hereto. 


THIS    SLIP    ORIGINATED    AS 


DIV.    ALARM    No 


Date  _. 


190_ 


CONTRACT 
ITEM    NO. 

OUANTITV                         UNIT 

DESCRIPTION     or     ARTICLE 

-1 

1  CERTIFT  THAT  th:  ABOVE  ARTICLE  IS  URGENTLY  NEEDED.  AND  IS  TO  BE  USED  AS  FOLLOWS: 

TIN  r«niwiu  b  f 

^S-Nk-fr-.w^-u..-    Il.b„l..„i- l.„,.b.  ...[,„.,...„ ,,..,™.l..r|.i-"~—      il...i....l.l..~..nl.l.., ......»«.    ".~ 

.„„„ 

U..rlli.^fto lunr  fca^i  of  lbl>  vln#t  f-r  ll.>l  furi-o...      11  ....«,  ,,.,.•  u  ^ryfti,  u  .a-Lltimjl  .hwl.  «m.  (lif,  oiaj  U  allirhtd  U.  iblj  lllp 

<f>— Ml  I*  Fiifiity  Cmh.l 


Rt  COMMENDATION-. 


(r«w«f4  1*  Dvpoly  Publk  PHvUt.i 


RECOMMENDATION. 


V  «mt#rm»a,  fomard  U,  Public  Prislct.f 


dats  alarm  slip  received 
date  of  purchase  order_ 
Ordered  from 


Purchase  Order  no. 
Date  of  oeliveri__ 


At  I 


(^  '  *•  Pnrch»«e  Order  coverlnir  this  Alarm  Slip  Is  drawn,  forward  the  orlslBal  to  t>»e  contractor  and  one  copy  to  1 
Caldanceand  iDformntlon.  one  ropy  to  Slorekecper,  oDc  copy  to  Che  AecoonttaK  Dlrl>laB.a«l  ««»  COM  to  Tropcrty  Hecords 
copy  In  the  Parchaslog  PlvUtoD.  

row  No.  BM, 

Figure  •) 


CHANGES  IN  GOVERNMENT  ACCOUNTING   335 


>.: 


INSTRUCTIONS. 


»C  ilil-i  Ainim  Siiii  orlcliiaiPS  In  -he  omcc  of  ihe  Secretary.  Congressional  Clerk,  Cashier  or  Paymaster,  Attorney,  Purchasing 
A"rni.  Accouiuonl.  or  ilic  Deputy  Public  Printer,  foruurd  direct  lo  the  Public  Printer.' 

"if  ihls  Alarm  slip  orlKln.Ties  In  tlic  Work  Division,  wlilcli  Includes  the  oolccor  the  Superintendent  of  Work,  or  the  Documents 
Division,  wlilcli  liiciudis  ilie  onicc  or  the  Superlniciideni  of  Documents,  It  will  receive  the  approval  or  disapproval  or  the  Super* 
IntcriiU-nt  of  Worit  or  the  supcrlnlcMdenl  of  Documenls  berorc  leaving  their  divisions. 

It  is  led  to  the  discretion  of  any  oincinl  at  any  time  to  ask  ror  the  data  or  certiacatlon  called  for  rrom  the  Property  Clerk 
and  siocU  Keeper.  . 

ON  CONTHACT  ITEMS,*  when  this  Alarm  Slip  Is  approved,  the  Purchasing  Agent  will  proceed  with  purchase,  provided  such 
action  will  not  cause  the  maximum  amount  or  stock  carried  to  be  exceeded  by  more  than  10  per  cent,  or  the  purchase  is  mado 
for  a  siioclal  Job  of  printing  or  binding,  otherwise  the  Purchasing'  Agent  "III  forward  tlio  Alarm  Slip  to  the  Public  Printer  for 
approval  before  (lie  purchase  order  Is  drawn. 

ON  orEN-MAItKliT  PUIICII ASES."  and  exclusive  of  emergency  requlrcmeni s.  all  quotations  received  on  account  of  this  Alarm 
.Slip  must  be  opened  at  a  specined  hour  in  llio  presence  of  a  commlllce  designated  tor  that  purpose,  when  they  are  examined, 
not.Tied,  and  submitted  to  the  Purchasing  Agent,  who  makes  a  recommendation  of  award,  and,  when  approved  by  the  Public 
Printer,  a  purchase  order  Is  placed  by  the   Purchasing  Agenu 

ON  EMEHCENCY  PUItCllASES,'  lo  be  made  In  the  open  markii,  the  Purcliasing  Agent  shall  proceed  with  the  least  possible 
delay  to  purchase,  in  accordance  with  the  provisions  of  la",  such  tiuantlty  or  the  article  called  for  In  this  Alarm  Slip  as  may. 
in  his  Judgment,  be  necessary  for  the  best  Interests  of  tlie  Governmen  l  and  to  relieve  the  emergency:  and,  should  the  price  or 
ilic  article  exceed  oiou,  It  shall  be  approved  by  the  Public  Printer  bt  fore  the  purchase  Is  made. 


olllx  ruMI^  Ihii 


1  f„i  Lii...  uroi»  t.i 


«H.ioial. 


.  by  tlie  {xrvori 


Pvo.x  O.DI.    No 


Cosr  F    O     B    G     P    O..  $. 


F    O    B    G    P    O.,  $. 


SPECIFICATIONS. 


Figure  ia 


336  HENRY  PARKER  WILLIS 

slip  carries  elaborate  data  regarding  the  methods,  and  de- 
tailed manufacturing  operations,  which  must  be  performed 
in  carrying  through  the  job.  On  the  back  of  the  informa- 
tion slip  is  given  a  detailed  analysis  of  the  charges  for  the 
job,  and  also  a  ''summary  of  labor  charges,"  in  which  all 
outlays  for  labor  are  grouped  as  ''composition  and  proof- 
reading," "foundrv^"  "presswork,"  "folding,"  "binding," 
and  "miscellaneous."  The  various  items  of  information 
are  filled  in  from  data  which  are  furnished  by  the  several 
sections  of  the  office  in  a  way  presently  to  be  indicated. 
It  is  to  be  noted  that  in  every  case  the  data  thus  supplied 
are  in  units  of  work  performed  while  the  costs  recorded 
on  the  jacket  information  slip  are  in  amounts  which  have 
been  computed  by  figuring  the  cost  of  the  different  opera- 
tions on  the  basis  of  the  uniform  scale  already  referred 
to,  as  applied  to  the  quantity  of  work  done  on  the  job  as 
reported.  From  this  jacket  information  slip,  when  fully 
made  up,  a  revised  estimate  of  total  cost  is  prepared.  In 
a  so-called  "allotment  book"  a  record  is  kept  of  the  differ- 
ent jobs  perfonned  for  the  various  bureaus  and  depart- 
ments, information  being  given  both  of  the  original  esti- 
mate, and  of  the  final  sum  charged  and  applied  against 
the  appropriation  allotted  by  Congress. 

The  nature  of  the  jacket  information  slip  can  be  easily 
understood  from  the  reproduction  herewith,  (Figures  2 
and  2a). 

In  order  to  get  the  information  necessary  in  making 
up  the  jacket  information  slip,  a  system  of  reports  on  work 
has  been  devised  by  the  public  printer.  These  reports 
originate  in  the  several  divisions  to  which  they  pertain, 
as  for  example,  foundry,  folding  room,  composition  and 
proofreading  division,  jaressroom,  cutting  and  packing  divi- 
sion, bindery  division,  and  building  division.  In  each  in- 
stance the  fundamental  forms  are  two  in  number,  a  ' '  daily 
report  of  work"  giving  the  name  of  the  operator  and  the 
time  spent  on  specified  operations.'  On  this  slip  each  of 


CHANGES  IN  GOVERNMENT  ACCOUNTING  337 


FOUNDRY, 
DAILY  REPORT  OF  WORK. 


certify  on  my  official  oath  that  the  time  noted  on  this 
report  is  correct. 

Date,   ,  190.. 

Name,    No... 

(Correct  Jacket  number  and  accurate  time  must  be  given.) 


Operation  No. 

Jacket  No. 

Time. 

Also  quantity  when 
so   ordered. 

A.M. 

0 

8.00 

2 

8.12 

4 

8.24 

6 

8.36 

8 

8.48 

10 

9.00 

12 

9.12 

14 

9.24 

16 

9.36 

18 

9.48 

20 

10.00 

22 

10.12 

24 

10.24 

26 

10.36 

28 

10.48 

. 

30 

11.00 

32 

11.12 

34 

11.24 

36 

11.36 

38 

11.48 

40 

12.00 

42 

12.12 

44 

12.24 

45 

12.30 
P.M. 

Ch 

eck  hourly  rate  h 

ere. 

Total. 

Wage 

1 

per  hr. 

.15 

.25  .30  .3 

1 

5  .40.45  .50  .55  .6^ 

)  .65  .70  .80 

$ , 

1       1       1 

(Foreman's  O.  K.) 
Figure  3A 


B— vni— 23 


838 


HENRY  PARKER  WILLIS 


Operation  No. 

Jacket  No. 

Time. 

Also  quantity  when 
so   ordered. 

P.M. 

45 

12.30 

46 

12.36 

48 

12.48 

50 

1.00 

52 

1.12 

54 

1.24 

56 

1.36 

58 

1.48 

60 

2.00 

62 

2.12 

64 

2.24 

66 

2.36 

68 

2.48 

70 

3.00 

72 

3.12 

74 

3.24 

76 

3.36 

78 

3.48 

80 

4.00 

82 

4.12 

84 

4.24 

85 

4.30 

86 

4.36 

88 

4.48 

90 

5.00 

P.M. 

01 

'ERATIC 

)NS. 

34.  Electrotype  molding. 

35.  Battery  work. 

36.  Backing  up. 

37.  Straightening. 

38.  Operating  finishing  ma- 

chine. 

39.  Revising. 

40.  Correcting. 

41.  Repairing  press  plates. 

42.  Joining  rules. 

43.  Solid  body  work. 

44.  Making  accents. 

45.  Stereotype  molding. 


46.  Stereotype  casting. 

47.  Making  slugs,  leads,  and 

furniture. 

48.  Casting  ingots. 

49.  Any    operation    not    on 

list — to  be  written  in, 

50.  Clerical,   helper,  messen- 

ger, or  laborer  work. 

51.  Waiting     time     (not    al- 

lowed unless  employe 
first  reports  this  fact 
to   chief). 
53.  Indeterminable. 


Figure  3A  (continued) 


CHANGES  IN  GOVERNMENT  ACCOUNTING  339 


4-1 

o 

60-  :  :  :  :  : 

1-  •-• 

4«-    i     •     "     •     * 

--1   <n 

I    '    !    '    !    ' 

in 

o 

l-H 

< 

o 

:::::: 

(J 

Q 

i< 

S 

:::::: 

Figure  3  A. 


O 


W 


3 
(30 


w 
u 

l-H 

o 
o 

l-H 

Ph 
H 
W 

W 
> 

o 

o 


c 

.S 

o 

in 

C 
O 

_o 

O 

O, 

E 
o 
U 

in 

^  s 

.  o 

1" 

Total   of  salaries  and  wages 
and  materials  and  supplies. 
Profit  (+)  or  loss  (—).... 

U-1       . 

O  J3 
■»-> 

\ 

c 

Eh 

340  HENRY  PARKER  WILLIS 

the  principal  operations  is  assigned  a  given  number,  as 
for  instance,  "79.  Folding."    In  the  main  body  of  the  slip 
appears  a  blank  for  the  number  of  the  ''jacket"  to  which 
the  operation  belongs,  and  a  series  of  numbers  dividing 
the  day  into  periods  of  six  minutes  each.    A  blank  is  left 
for  the  recording  of  the  number  of  the  operation.    On  a 
completed  slip,  therefore,  appear  data  as  to  the  name  of 
the  operator,  the  approximate  time  at  which  he  has  begun 
and  discontinued  a  given  operation  (which  is  specified  by 
number),  and  the  rate  of  wages  per  hour.     The  second 
fundamental  blank  is  intended  to  assemble  the  results  of 
the  daily  report  of  work,  and  is  entitled  "abstract  of  labor 
charges."    This  is  prepared  by  the  officer  in  general  charge 
of  the  work,  and  gives  the  totals  which  have  been  arrived 
at  by  the  individual  employes  themselves  as  recorded  on 
their  daily  report  of  work.     Inasmuch  as  the  work  has 
already  been  classified  by  principal  operations,  it  is  easy 
to  group  the  total  cost  of  each  operation  as  derived  from 
the  several  individual  daily  time  slips  in  the  abstract  of 
labor  charges.    The  slips,  however,  are  used  only  in  cases 
where  the  product  cannot  be  measured  in  a  more  econom- 
ical way  by  a  single  individual  acting  for  all.     One  ab- 
stract of  labor  charges  is  made  out  for  each  jacket  informa- 
tion slip,  being  numbered  accordingly.    The  combined  re- 
sults of  the  labor  charges  supply  the  information  for  filling 
up  the  slip  in  those  divisions  of  the  slip  which  relate  to 
labor.     The  portions  which  relate  to  paper  are  filled  in 
from  the  requisitions  which  have  been  made  for  supplies 
to  be  used  in  preparing   the    given   job.      Miscellaneous 
items  are  covered  from  the  general  uniform  scale.     The 
final  result  of  the  information  slip  shows  the  combination 
of  outlay  for  labor  and  outlay  for  supplies,  the  latter  esti- 
mated at  cost  price,  the  former  at  the  fixed  scale  of  charges 
for  work  already  referred  to.    At  the  end  of  each  month 
a  compiled  statement  is  made  up  showing  the  "distribu- 
tion of  labor  charges  on  work  completed  during  month 


CHANGES  IN  GOVERNMENT  ACCOUNTING  341 

of   "     From  this  comparisons  can  be  made 

with  the  amount  actually  charged  to  the  departments,  and 
the  uniform  scale  can  from  time  to  time  be  raised  or  low- 
ered as  occasion  may  demand.  As  illustrating  this  system 
for  assigning  labor  costs,  specimen  forms  are  herewith  re- 
produced (Figures  3A,  3B,  and  3C). 

Cost  Analysis  at  the  Mints. 

One  of  the  most  clear-cut  examples  of  the  use  of  a  sys- 
tem of  cost  accounting  in  the  government  service  is  found 
in  the  United  States  mints.  The  system  was  introduced 
as  a  result  of  the  work  of  the  Committee  on  Department 
Methods,  which  recommended  that  the  methods  of  book- 
keeping at  the  mints  be  adjusted  with  a  view  to  detailed 
analyses  of  cost.  Under  the  system  then  introduced  a 
monthly  report  is  returned  by  each  of  the  mints  of  the 
United  States  to  the  Director  of  the  Mint  at  Washington. 
Each  of  these  reports  is  an  abstract  of  the  books  of  the 
mint  for  the  preceding  month,  and  inasmuch  as  the  prod- 
uct of  the  establishment  is  uniform,  and  costs  are  readily 
segregated,  the  system  has  easily  been  made  to  show  the 
output  of  coin,  the  actual  cost  of  each  operation  in  gross, 
and  the  distribution  of  this  cost  per  unit  of  coinage.  Thus 
the  Philadelphia  Mint  in  its  report  discriminates  between 
the  weigh  clerk's  office,  deposit  melting  room,  deposit  as- 
saying department,  calculating  department,  refinery,  sweep 
cellar,  assay ^.  department,  engraving  department,  ingot 
melting  room,  rolling,  cutting  and  annealing  department, 
adjusting  and  weighing  department,  upsetting,  coining 
and  delivering  department,  and  superintendent's  depart- 
ment. From  the  data  thus  furnished  the  cost  per  thou- 
sand pieces  of  each  product  is  compiled.  This  then  gives 
the  cost  per  unit.  By  comparing  this  with  the  average 
cost  per  thousand  pieces  as  obtained  over  a  series  of  months 
and  years,  the  actual  running  costs  can  be  compared  with 
what  experience  has  shown  they  should  be. 


342  HENRY  PARKER  WILLIS 

This  system  of  accounting  involves  a  careful  and  elab- 
orate classification  of  operations.  For  example,  in  the  re- 
finery there  is  reported  first  of  all  the  product  classified 
into  fine  ounces  of  gold  and  fine  ounces  of  silver.  The 
costs  are  then  classified  as  follows:  (a)  labor,  (b)  melting 
and  refining  in  general,  (c)  leave,  (d)  crucibles,  (e)  mitts 
and  gloves,  (f)  acids,  (g)  fuel,  (h)  furnace  repairs,  (i)  me- 
chanical repairs,  (j)  incidentals,  (k)  electrical  current, 
(1)  chemicals,  (m)  sweep  cellar,  (n)  assays,  and  (o)  light 
and  ventilation.  The  aggregate  divided  by  the  number 
of  fine  ounces  gives  the  cost  per  fine  ounce,  which,  by  com- 
parison with  former  months,  shows  the  relation  between 
these  costs  and  the  average  cost  per  fine  ounce.  In  the 
assay  department  product  is  reported  as  ''number  of 
assays  made,"  which  is  divided  among  ''deposits,"  "in- 
gots," "refinery,"  and  "miscellaneous."  The  costs  in  the 
assaying  department  are  divided  between  (a)  labor,  (b) 
leave,  (c)  material,  (d)  fuel,  (e)  mechanical  repairs,  (f)' 
power,  and  (g)  light  and  ventilation.  These  costs  are  then 
distributed  among  the  four  groups  into  which  the  number 
of  assays  made  is  sub-classified.  The  ingot  assays  are  then 
distributed  to  the  denominations  of  coin,  as  double  eagles, 
half  eagles,  etc.  From  this  is  derived  the  cost  per  assay 
which  can  then  be  compared  with  the  average  cost  per 
assay  as  shown  by  former  reports. 

It  is  thus  seen  that  the  sole  object  of  the  cost-account- 
ing system  in  use  at  the  mints  is  that  of  distributing  labor 
charges  and  material  charges  to  the  various  classes  of  coin 
and  other  products  turned  out,  for  the  purpose  of  making 
comparisons  with  an  average  standard.  The  system  is  pro- 
nounced exceedingly  satisfactory,  and  has  afforded  a  very 
much  better  analysis  of  mint  operations  than  was  practi- 
cable prior  to  its  introduction.  A  rough  general  distribu- 
tion of  costs  was  always  practicable  owing  to  the  simplic- 
ity of  the  manufacturing  operations  performed  while  the 
non-commercial  character  of  the  mints  made  it  less  neces- 


CHANGES  IN  GOVERNMENT  ACCOUNTING  343 

sary  from  any  immediate  standpoint  to  know  the  relative 
outlays  on  each  operation.  It  has  been  found,  however, 
that  the  comparative  analyses  rendered  possible  by  the 
new  system,  make  strongly  for  good  administration,  and 
render  it  possible  to  locate  sources  of  unnecessary  or 
excessive  cost.* 

Statistical  Costs. 

An  excellent  example  of  what  can  be  done  in  estimating 
and  apportioning  the  cost  of  statistical  work  in  the  gov- 
ernment service  has  recently  been  afforded  by  the  Census 
Bureau.f  This  office,  after  considerable  investigation,  has 
finally  developed  a  complete  plan  for  keeping  track  of  the 
outlays  on  pay-roll  and  for  classifying  at  the  end  of  each 
month  the  various  objects  to  which  the  money  expended 
has  been  devoted. 

The  cost-accounting  system  of  the  Census  Office  is  based 
upon  the  idea  that  every  outlay  made  through  the  pay- 
roll is  for  a  distinct  object,  and  must  be  reported  in  con- 
nection with  that  object.  Each  member  of  the  Census 
Office  staff  is  assigned  a  number,  and  makes  out  a  daily 
time  slip,  upon  which  appear  certain  facts.  The  time  slip 
contains  blanks  for  the  name  of  the  employe,  the  number 
assigned  him,  the  division  of  the  office  in  which  he  works, 
the  number  of  his  clerical  class  (whether  1st,  2d,  3d,  etc.), 
and  absences  if  any.  Upon  the  slip  are  also  given  spaces 
to  be  filled  in  with  the  number  of  the  inquiry  upon  which 
the  employe  is  engaged,  the  character  of  the  work,  and 
the  amount  of  time  spent.  On  the  back  of  the  slip  appears 
a  classification  giving  seven  main  operations  representing 
the  work  of  the  office  as  follows:   (1)  field  work;  (2)  labor; 


*The  foregoing  account  of  the  cost  system  of  the  mints  is  based  upon 
information  kindly  furnished  by  Hon.  Frank  A.  Leach,  ex-Director  of  the 
United  States  Mint,  who  has  supplied  the  writer  with  the  detailed  data  of 
which  the  text  furnishes  a  brief  summary. 

t  For  detailed  data  and  explanations  concerning  the  cost-keeping  system 
of  the  Census  Bureau  I  am  indebted  to  Hon.  W.  S.  Rossiter,  Chief  Clerk  of  the 
Census,  who  has  had  charge  of  the  introduction  of  the  system. 


344  HENRY  PARKER  WILLIS 

(3)  miscellaneous  clerical;  (4)  publishing;  (5)  statistical; 
(6)  stenography  and  typewriting;  (7)  supervisory.  Each 
of  these  main  topics  is  largely  subdivided,  there  being  about 
forty  sub-classifications,  into  some  one  of  which  the  labor 
of  each  clerk  will  fall.  It  does  not  follow  of  course  that 
a  given  clerk  spends  his  whole  daily  time  upon  any  one 
subject.  Usually  he  will  perform  labor  which  is  classi- 
fiable under  two  or  more  of  these  sub-heads.  In  that  event 
he  must  record  upon  his  daily  report  the  amount  of  time 
spent  on  each  operation,  showing  the  distribution  between 
the  several  classes  of  work.  After  the  slips  have  been 
made  up  as  above  indicated,  they  are  carefully  examined 
by  the  time  clerk  of  the  division  in  which  they  originate, 
for  the  purpose  of  detecting  any  inconsistencies  or  mani- 
fest errors.  They  are  then  sent  to  the  cost-accounting  sec- 
tion. It  should  be  noted  that  in  cases  where  clerks  are 
absent  from  the  office  on  leave,  or  are  out  upon  the  road 
engaged  in  field  work,  a  slip  is  made  out  for  each  by  the 
time  keeper  of  the  division  to  which  each  belongs,  and  is 
sent  in  with  the  other  slip.  When  all  the  slips  have  been 
received  in  the  cost-accounting  section  the  clerks  in  charge 
of  that  section  punch  cards  representing  the  data  which 
are  presented  upon  each  slip.  This  punching  process 
is  the  same  which  was  followed  in  the  last  decennial  census 
and  is  performed  by  the  use  of  the  so-called  Hollerith  ma- 
chine. The  cards  in  question  are  printed  with  a  series  of 
columns  showing  the  date,  the  office  or  field  of  the  worker, 
the  employe,  the  division  in  which  employed,  the  grade 
of  the  clerk,  the  inquiry  to  which  attached,  the  character 
of  the  work  done,  the  time  employed,  the  rate  per  hour 
paid,  and  the  total  amount  paid.  Under  each  of  these 
headings  the  appropriate  data  are  represented  by  num- 
bers, and  inasmuch  as  each  employe,  division,  grade,  in- 
quiry, character  of  work,  etc.,  has  a  definite  number 
previously  assigned  to  it,  it  is  thus  possible  to  record  nu- 
merically b}^  punch  marks  in  the  appropriate  squares  the 


CHANGES  IN  GOVERNMENT  ACCOUNTING  345 

data  which  has  been  recorded  in  words  upon  the  daily 
time  slip.  After  the  cards  have  been  punched  they  are 
sorted  into  groups  according  to  rates  of  pay,  and  then  ac- 
cording to  time  employed.  The  sorting  is  simply  done 
by  grouping  together  all  cards  which  have  uniform  punch 
marks  in  the  sections  referred  to  (rate  of  pay  and  time), 
needles  being  thrust  through  the  appropriate  holes  as  the 
cards  stand  stacked  in  order  to  see  that  all  are  punched 
in  the  same  area.  If  they  are  so  punched,  they  belong  to 
the  same  group,  while  if  others  not  so  punched  have  been 
included,  the  needles  will  not  pass  through  completely,  and 
it  is  necessary  to  withdraw  certain  cards,  which  have 
(erroneously  been  thrown  into  this  group. 

The  work  thus  done  gives  a  money  classification,  and 
practice  has  shown  that  the  results  correspond  to  within 
$100  per  month  with  the  results  shown  by  the  pay-roll,  the 
latter  amounting  to  about  $58,000  monthly.*  It  would  be 
possible  to  make  the  system  register  to  a  cent  by  going 
sufficiently  into  detail,  but  this  has  not  been  thought  neces- 
sary. The  next  operation  is  to  sort  the  cards  by  fields 
and  classes  of  work.  The  processes  are  simply  those  of 
sorting  and  adding  after  the  manner  already  indicated,  but 
for  the  purpose  of  obtaining  different  groupings  or  classi- 
fications. These  groupings  and  classifications  have  been 
designed  to  show  the  head  of  the  Census  Bureau  exactly 
where  the  money  that  has  been  paid  out  has  gone — that 
is  to  say,  for  what  specific  objects  it  has  been  expended. 
In  order  to  give  these  data,  tabular  forms  showing  the 
seven  classes  already  referred  to  (supervisory,  statistical, 
publishing,  field  work,  stenography  and  typewriting,  mis- 
cellaneous clerical,  and  labor  mth  an  eighth  ''administra- 
tive") have  been  ruled.  After  the  cards  have  been  sepa- 
rated into  groups  according  to  these  main  classes  of  work, 


*  This  figure  applies  to  the  expenses  of  the  bureau  in  "ordinary"  years, 
that  is,  years  when  the  regular  decennial  census  is  not  in  progress.  When 
the  decennial  census  is  going  on,  the  outlay  is  much  larger. 


346  ,     HENRY  PARKER  WILLIS 

all  those  belonging  in  the  various  sub-elassifieations  being 
of  course  grouped  under  the  main  head  to  which  they  be- 
long, they  are  totaled  by  the  usual  statistical  methods,  and 
the  results  are  recorded,  under  the  headings  described,  as 
"Table  1,"  on  which  are  shown  the  corresponding  results 
for  the  similar  month  of  the  preceding  year.  "Table  lA" 
has  the  same  headings,  but  is  represented  in  percentages 
for  the  purpose  of  showing  the  relationship  between  the 
different  groups  of  work.  "Table  2"  has  the  same  head- 
ings, but  is  limited  to  the  "cost  of  inquiries  in  progress, 
by  specified  classes  of  work."  ** Table  2A"  shows  under 
the  same  headings  as  before  the  per  cent  which  the  cost 
of  inquiries  in  progress  by  specified  classes  of  work  forms 
of  the  total  expenditures.  "Table  3"  is  made  out  sep- 
arately for  each  inquiry  which  is  in  progress,  and  shows 
under  the  familiar  headings  the  distribution  of  costs  upon 
that  particular  investigation.  "Table  4"  is  limited  to 
"productive  labor,"  which  includes  all  except  the  "ad- 
ministrative" and  "supervisory"  divisions.  "Table  4A" 
gives  under  the  same  heads  as  the  last  the  percentage  which 
the  cost  of  productive  labor  forms  of  total  expenditures. 
"Table  5"  is  limited  to  "non-productive  labor,"  which,  as 
we  have  seen,  includes  the  supervisory  and  administra- 
tive groupings.  In  making  the  distribution  of  the  cost  of 
non-productive  labor,  however,  separate  columns  are  pro- 
vided for  the  director's  division,  chief  clerk's  division,  dis- 
bursements and  appointments  division,  library,  and  corre- 
spondence and  mailing.  "Table  5A"  gives  these  same 
data  in  percentages.  "Table  6"  is  designed  to  show  the 
cost  of  annual  leave  "by  specified  classes  of  work.  The 
subdivision  is  here  made  on  the  original  seven  groups  al- 
ready referred  fo,  the  entries  being  those  which  relate  t'o» 
the  leave  granted  the  employes  m  eacK  division.  "Tabl6 
6A"  gives  the  same  data  as  "Table  6"  in  the  form  of  per- 
centages. "Table  7"  gives  the  same  grouping  for  the  cost' 
of  sick  leave  by  specified  classes  of  work,  and  **  Table  7A" 


CHANGES  IN  GOVERNMENT  ACCOUNTING  347 

tlie  percentage  which  cost  of  sick  leave  by  specified  classes 
of  work  forms  of  the  total  pay-roll  distribution.  As  already 
stated,  these  tables  are  prepared  each  month,  and  within 
three  days  of  the  opening  of  a  new  month  are  furnished 
to  the  head  of  the  office  for  study  and  comparison. 

Effect  of  Changes. 

The  general  effect  of  the  changes  in  accounting  method 
which  have  been  discussed  in  the  foregoing  pages  has  been 
good.  Both  these  and  other  innovations  have  operated  to 
put  the  service  of  the  Government  upon  a  much  more  busi- 
nesslike basis  than  has  heretofore  been  characteristic,  and 
have  been  merely  the  outward  manifestation  of  a  spirit 
of  greater  attention  to  detail,  and  desire  to  get  results 
in  economy  and  efficiency  that  has  transformed  some  of 
the  branches  of  the  Government  in  an  almost  radical  way. 
No  one  would  suppose  for  a  moment  that  the  public  serv- 
ice is  as  yet  upon  a  basis  of  full  efficiency,  or  that  it  could 
compare  in  quickness  or  economy  of  results  with  even 
moderately  successful  business  houses.  But  enough  has 
been  done  to  hold  out  hopes  of  improvement  in  the  future 
to  those  who  believe  in  thorough  and  conscientious  work. 
The  ideals  of  the  public  service  are  not  and  never  will  be 
identical  with  those  which  prevail  in  the  commercial  world. 
The  standard  of  payment  is  not  the  same,  nor  is  the  object 
of  accounting  and  other  forms  of  organization  the  same 
in  the  government  department  as  it  is  in  the  private  busi- 
ness. Reduction  of  costs  of  operation,  uniformity  of  ex- 
penditure and  accounting  method,  and  proper  safeguards 
against  unusual  extravagance  or  official  peculation  may 
reasonably  be  looked  for.  These  the  federal  administra- 
tion is  now  in  a  fair  way  to  secure 


SECTION  D. 

CORPORATION  TAX  REGULATIONS. 

Regulations  relating  to  the  assessment  and  collection 
of  the  special  excise  tax  imposed  by  Section  38,  act  of 
August  5,  1909,  on  corporations,  joint  stock  companies, 
associations,  and  insurance  companies. 

Section  38  of  the  act  of  August  5, 1909,  is  as  follows: 

Sec.  38.  That  every  corporation,  joint  stock  company  or  association,  or- 
ganized for  profit  and  having  a  capital  stock  represented  by  shares,  and  every 
insurance  company,  now  or  hereafter  organized  under  the  laws  of  the  United 
States  or  of  any  State  or  Territory  of  the  United  States  or  under  the  acts  of 
Congress  applicable  to  Alaska  or  the  District  of  Columbia,  or  now  or  here- 
after organized  under  the  laws  of  any  foreign  country  and  engaged  in  busi- 
ness in  any  State  or  Territory  of  the  United  States  or  in  Alaska  or  in  the 
District  of  Columbia,  shall  be  subject  to  pay  annually  a  special  excise  tax 
with  respect  to  the  carrying  on  or  doing  business  by  such  corporation,  joint 
stock  company  or  association,  or  insurance  company,  equivalent  to  one  per 
centum  upon  the  entire  net  income  over  and  above  five  thousand  dcillars  re- 
ceived by  it  from  all  sources  during  such  year,  exclusive  of  amounts  received 
by  it  as  dividends  upon  stock  of  other  corporations,  joint  stock  companies  or 
associations,  or  insurance  companies,  subject  to  the  tax  hereby  imposed;  or 
if  organized  under  the  laws  of  any  foreign  country,  upon  the  amount  of  net 
income  over  and  above  five  thousand  dollars  received  by  it  from  business 
transacted  and  capital  invested  within  the  United  States  and  its  Territories, 
Alaska,  and  the  District  of  Columbia  during  such  year,  exclusive  of  amounts 
so  received  by  it  as  dividends  upon  stock  of  other  corporations,  joint  stock 
companies  or  associations,  or  insurance  companies,  subject  to  the  tax  hereby 
imposed:  Provided,  however,  That  nothing  in  this  section  contained  shall  apply 
to  labor,  agricultural  or  horticultural  organizations,  or  to  fraternal  beneficiary 
societies,  orders,  or  associations  operating  under  the  lodge  system,  and  pro- 
viding for  the  payment  of  life,  sick,  accident,  and  other  benefits  to  the  mem- 
bers of  such  societies,  orders,  or  associations,  and  dependents  of  such  mem- 
bers, nor  to  domestic  building  and  loan  associations,  organized  and  operated 
exclusively  for  the  mutual  benefit  of  their  members,  nor  to  any  corporation 
or  association  organized  and  operated  exclusively  for  religious,  charitable,  or 
educational  purposes,  no  part  of  the  net  income  of  which  inures  to  the  benefit 
of  any  private  stockholder  or  individual. 

Second.  Such  net  income  shall  be  ascertained  by  deducting  from  the  gross 
amount  of  the  income  of  such  corporation,  joint  stock  company  or  association, 
or  insurance  company,  received  within  the  year  from  all  sources,  (first)  all  the 
ordinary  and  necessary  expenses  actually  paid  within  the  year  out  of  income 
in  the  maintenance  and  operation  of  its  business  and  properties,  including  all 

348 


CORPORATION  TAX  REGULATIONS         349 

charges  such  as  rentals  or  franchise  payments,  required  to  be  made  as  a 
condition  to  the  continued  use  or  possession  of  property;  (second)  all  losses 
actually  sustained  within  the  year  and  not  compensated  by  insurance  or  other- 
wise, including  a  reasonable  allowance  for  depreciation  of  property,  if  any, 
and  in  the  case  of  insurance  companies  the  sums  other  than  dividends,  paid 
within  the  year  on  policy  and  annuity  contracts  and  the  net  addition,  if  any, 
required  by  law  to  be  made  within  the  year  to  reserve  funds;  (third)  interest 
actually  paid  within  the  year  on  its  bonded  or  other  indebtedness  to  an  amount 
of  such  bonded  and  other  indebtedness  not  exceeding  the  paid-up  capital 
stock  of  such  corporation,  joint  stock  company  or  association,  or  insurance 
company,  outstanding  at  the  close  of  the  year,  and  in  the  case  of  a  bank, 
banking  association,  or  trust  company,  all  interest  actually  paid  by  it  within 
the  year  on  deposits;  (fourth)  all  sums  paid  by  it  within  the  year  for  taxes 
imposed  under  the  authority  of  the  United  States  or  of  any  State  or  Territory 
thereof,  or  imposed  by  the  government  of  any  foreign  country  as  a  condition 
to  carrying  on  business  therein;  (fifth)  all  amounts  received  by  it  within  the 
year  as  dividends  upon  stock  of  other  corporations,  joint  stock  companies  or 
associations,  or  insurance  companies,  subject  to  the  tax  hereby  imposed: 
Provided,  That  in  the  case  of  a  corporation,  joint  stock  company  or  associa- 
tion, or  insurance  company,  organized  under  the  laws  of  a  foreign  country, 
such  net  income  shall  be  ascertained  by  deducting  from  the  gross  amount  of 
its  income  received  within  the  year  from  business  transacted  and  capital  in- 
vested within  the  United  States  and  any  of  its  Territories,  Alaska,  and  the 
District  of  Columbia,  (first)  all  the  ordinary  and  necessary  expenses  actually 
paid  within  the  year  out  of  earnings  in  the  maintenance  and  operation  of  its 
business  and  property  within  the  United  States  and  its  Territories,  Alaska, 
and  the  District  of  Columbia,  including  all  charges  such  as  rentals  or  franchise 
payments  required  to  be  made  as  a  condition  to  the  continued  use  or  posses- 
sion of  property;  (second)  all  losses  actually  sustained  within  the  year  in 
business  conducted  by  it  within  the  United  States  or  its  Territories,  Alaska, 
or  the  District  of  Columbia  not  compensated  by  insurance  or  otherwise,  in- 
cluding a  reasonable  allowance  for  depreciation  of  property,  if  any,  and  in  the 
case  of  insurance  companies  the  sums  other  than  dividends,  paid  within  the 
year  on  policy  and  annuity  contracts  and  the  net  addition,  if  any,  required  by 
law  to  be  made  within  the  year  to  reserve  funds;  (third)  interest  actually  paid 
within  the  year  on  its  bonded  or  other  indebtedness  to  an  amount  of  such 
bonded  and  other  indebtedness,  not  exceeding  the  proportion  of  its  paid-up 
capital  stock  outstanding  at  the  close  of  the  year  which  the  gross  amount  of 
its  income  for  the  year  from  business  transacted  and  capital  invested  within 
the  United  States  and  any  of  its  Territories,  Alaska,  and  the  District  of  Co- 
lumbia bears  to  the  gross  amount  of  its  income  derived  from  all  sources  within 
and  without  the  United  States;  (fourth)  the  sums  paid  by  it  within  the  year 
for  taxes  imposed  under  the  authority  of  the  United  States  or  of  any  State  or 
Territory  thereof;  (fifth)  all  amounts  received  by  it  within  the  year  as  divi- 
dends upon  stock  of  other  corporations,  joint  stock  companies  or  associations, 
and  insurance  companies,  subject  to  the  tax  hereby  imposed.  In  the  case  of 
assessment  insurance  companies  the  actual  deposit  of  sums  with  State  or 
Territorial  ofhcers,  pursuant  to  law,  as  additions  to  guaranty  or  reserve  funds 
shall  be  treated  as  being  payments  required  by  law  to  reserve  funds. 

Third.  There  shall  be  deducted  from  the  amount  of  the  net  income  of 
each  of  such  corporations,  joint  stock  companies  or  associations,  or  insurance 
companies,  ascertained  as  provided  in  the  foregoing  paragraphs  of  this  section, 
the  sum  of  five  thousand  dollars,  and  said  tax  shall  be  computed  upon  the 
remainder  of  said  net  income  of  such  corporation,  joint  stock  company  or 
association,  or  insurance  company,  for  the  year  ending  December  thirty-first, 
nineteen  hundred  and  nine,  and  for  each  calendar  year  thereafter;  and  on  or 


350         CORPORATION  TAX  REGULATIONS 

before  the  first  day  of  March,  nineteen  hundred  and  ten,  and  the  first  day  of 
March  in  each  year  thereafter,  a  true  and  accurate  return  under  oath  or 
affirmation  of  its  president,  vice-president,  or  other  principal  officer,  and  its 
treasurer  or  assistant  treasurer,  shall  be  made  by  each  of  the  corporations, 
joint  stock  companies  or  associations,  and  insurance  companies,  subject  to 
the  tax  imposed  by  this  section,  to  the  collector  of  internal  revenue  for  the 
district  in  which  such  corporation,  joint  stock  company  or  association,  or 
insurance  company  has  its  principal  place  of  business,  or,  in  the  case  of  a 
corporation,  joint  stock  company  or  association,  or  insurance  company,  or- 
ganized under  the  laws  of  a  foreign  country,  in  the  place  where  its  principal 
business  is  carried  on  within  the  United  States,  in  such  form  as  the  Com- 
missioner of  Internal  Revenue,  with  the  approval  of  the  Secretary  of  the 
Treasury,  shall  prescribe,  setting  forth  (first)  the  total  amount  of  the  paid-up 
capital  stock  of  such  corporation,  joint  stock  company  or  association,  or  in- 
surance company,  outstanding  at  the  close  of  the  year;  (second)  the  total 
amount  of  the  bonded  and  other  indebtedness  of  such  corporation,  joint  stock 
company  or  association,  or  insurance  company  at  the  close  of  the  year; 
(third)  the  gross  amount  of  the  income  of  such  corporation,  joint  stock 
company  or  association,  or  insurance  company,  received  during  such  year 
from  all  sources,  and  if  organized  under  the  laws  of  a  foreign  country  the 
gross  amount  of  its  income  received  within  the  year  from  business  transacted 
and  capital  invested  within  the  United  States  and  any  of  its  Territories, 
Alaska,  and  the  District  of  Columbia;  also  the  amount  received  by  such  cor- 
poration, joint  stock  company  or  association,  or  insurance  company,  within 
the  year  by  way  of  dividends  upon  stock  of  other  corporations,  joint  stock 
companies  or  associations,  or  insurance  companies,  subject  to  the  tax  imposed 
by  this  section;  (fourth)  the  total  amount  of  all  the  ordinary  and  necessary 
expenses  actually  paid  out  of  earnings  in  the  maintenance  and  operation  of 
the  business  and  properties  of  such  corporation,  joint  stock  company  or  as- 
sociation, or  insurance  company,  within  the  year,  stating  separately  all 
charges  such  as  rentals  or  franchise  payments  required  to  be  made  as  a  condi- 
tion to  the  continued  use  or  possession  of  property,  and  if  organized  under 
the  laws  of  a  foreign  country  the  amount  so  paid  in  the  maintenance  and 
operation  of  its  business  within  the  United  States  and  its  Territories,  Alaska, 
and  the  District  of  Columbia;  (fifth)  the  total  amount  of  all  losses  actually 
sustained  during  the  year  and  not  compensated  by  insurance  or  otherwise, 
stating  separately  any  amounts  allowed  for  depreciation  of  property,  and  in 
the  case  of  insurance  companies  the  sums  other  than  dividends,  paid  within 
the  year  on  policy  and  annuity  contracts  and  the  net  addition,  if  any,  required 
by  law  to  be  made  within  the  year  to  reserve  funds;  and  in  the  case  of  a 
corporation,  joint  stock  company  or  association,  or  insurance  company,  or- 
ganized under  the  laws  of  a  foreign  country,  all  losses  actually  sustained  by 
it  during  the  year  in  business  conducted  by  it  within  the  United  States  or  its 
Territories,  Alaska,  and  the  District  of  Columbia,  not  compensated  by  in- 
surance or  otherwise,  stating  separately  any  amounts  allowed  for  deprecia- 
tion of  property,  and  in  the  case  of  insurance  companies  the  sums  other  than 
dividends,  paid  within  the  year  on  policy  and  annuity  contracts  and  the  net 
addition,  if  any,  required  by  law  to  be  made  within  the  year  to  reserve  fund; 
(sixth)  the  amount  of  interest  actually  paid  within  the  year  on  its  bonded  or 
other  indebtedness  to  an  amount  of  such  bonded  and  other  indebtedness  not 
exceeding  the  paid-up  capital  stock  of  such  corporation,  joint  stock  company 
or  association,  or  insurance  company,  outstanding  at  the  close  of  the  year, 
and  in  the  case  of  a  bank,  banking  association,  or  trust  company,  stating 
separately  all  interest  paid  by  it  within  the  year  on  deposits;  or  in  case  of  a 
corporation,  joint  stock  company  or  association,  or  insurance  company,  or- 
ganized under  the  laws  of  a  foreign  country,  interest  so  paid  on  its  bonded 


CORPORATION  TAX  REGULATIONS         351 

or  other  indebtedness  to  an  amount  of  such  bonded  and  other  indebtedness 
not  exceeding  the  proportion  of  its  paid-up  capital  stock  outstanding  at  the 
close  of  the  year,  which  the  gross  amount  of  its  income  for  the  year  from 
business  transacted  and  capital  invested  within  the  United  States  and  any  of 
its  Territories,  Alaska,  and  the  District  of  Columbia,  bears  to  the  gross 
amount  of  its  income  derived  from  all  sources  within  and  without  the  United 
States;  (seventh)  the  amount  paid  by  it  within  the  year  for  taxes  imposed 
under  the  authority  of  the  United  States  or  any  State  or  Territory  thereof,  and 
separately  the  amount  so  paid  by  it  for  taxes  imposed  by  the  government  of 
any  foreign  country  as  a  condition  to  carrying  on  business  therein;  (eighth) 
the  net  income  of  such  corporation,  joint  stock  company  or  association,  or 
insurance  company,  after  making  the  deductions  in  this  section  authorized. 
All  such  returns  shall  as  received  be  transmitted  forthwith  by  the  collector  to 
the  Commissioner  of  Internal  Revenue. 

Fourth.  Whenever  evidence  shall  be  produced  before  the  Commissioner 
of  Internal  Revenue  which  in  the  opinion  of  the_  (Commissioner  justifies  the 
belief  that  the  return  made  by  any  corporation,  joint  stock  company  or  as- 
sociation, or  insurance  company,  is  incorrect,  or  whenever  any  collector  shall 
report  to  the  Commissioner  of  Internal  Revenue  that  any  corporation,  joint 
stock  company  or  association,  or  insurance  company  has  failed  to  make  a 
return  as  required  by  law,  the  Commissioner  of  Internal  Revenue  may  re- 
quire from  the  corporation,  joint  stock  company  or  association,  or  insurance 
company  making  such  return,  such  further  information  with  reference  to  its 
capital,  income,  losses,  and  expenditures  as  he  may  deem  expedient;  and  the 
Commissioner  of  Internal  Revenue,  for  the  purpose  of  ascertaining  the  cor- 
rectness of  such  return  or  for  the  purpose  of  making  a  return  where  none 
has  been  made,  is  hereby  authorized,  by  any  regularly  appointed  revenue  agent 
specially  designated  by  him  for  that  purpose,  to  examine  any  books  and 
papers  bearing  upon  the  matters  required  to  be  included  in  the  return  of 
such  corporation,  joint  stock  company  or  association,  or  insurance  company, 
and  to  require  the  attendance  of  any  officer  or  employe  of  such  corporation, 
joint  stock  company  or  association,  or  insurance  company,  and  to  take  his 
testimony  with  reference  to  the  matter  required  by  law  to  be  included  in  such 
return,  with  power  to  administer  oaths  to  such  person  or  persons;  and  the 
Commissioner  of  Internal  Revenue  may  also  invoke  the  aid  of  any  court  of 
the  United  States  having  jurisdiction  to  require  the  attendance  of  such  offi- 
cers or  employes  and  the  production  of  such  books  and  papers.  Upon  the 
information  so  acquired  the  Commissioner  of  Internal  Revenue  may  amend 
any  return  or  make  a  return  where  none  has  been  made.  All  proceedings  taken 
by  the  Commissioner  of  Internal  Revenue  under  the  provisions  of  this  section 
shall  be  subject  to  the  approval  of  the  Secretary  of  the  Treasury. 

t  Fifth.  AH  returns  shall  be  retained  by  the  Commissioner  of  Internal 
Revenue,  who  shall  make  assessments  thereon;  and  in  case  of  any  return 
made  with  false  or  fraudulent  intent,  he  shall  add  one  hundred  per  centum 
of  such  tax,  and  in  case  of  a  refusal  or  neglect  to  make  a  return  or  to  verify 
the  same  as  aforesaid  he  shall  add  fifty  per  centum  of  such  tax.  In  case  of 
neglect  occasioned  by  the  sickness  or  absence  of  an  officer  of  such  corpora- 
tion, joint  stock  company  or  association,  or  insurance  company,  required  to 
make  said  return,  or  for  other  sufficient  reason,  the  collector  may  allow  such 
further  time  for  making  and  delivering  such  return  as  he  may  deem  necessary, 
not  exceeding  thirty  days.  The  amount  so  added  to  the  tax  shall  be  collected 
at  the  same  time  and  in  the  same  manner  as  the  tax  originally  assessed, 
unless  the  refusal,  neglect,  or  falsity  is  discovered  after  the  date  for  payment 
of  said  taxes,  in  which  case  the  amount  so  added  shall  be  paid  by  the  de- 
linquent corporation,  joint  stock  company  or  association,  or  insurance  com- 
pany, immediately  upon  notice  given  by  the  collector.  All  assessments  shall 
be  made  and  the  several  corporations,  joint  stock  companies  or  associations, 


352         CORPORATION  TAX  REGULATIONS 

or  insurance  companies,  shall  be  notified  of  the  amount  for  which  they  are 
respectively  liable  on  or  before  the  first  day  of  June  of  each  successive  year, 
and  said  assessments  shall  be  paid  on  or  before  the  thirtieth  day  of  June, 
except  in  cases  of  refusal  or  neglect  to  make  such  return,  and  in  cases  of 
false  or  fraudulent  returns,  in  which  cases  the  Commissioner  of  Internal 
Revenue  shall,  upon  the  discovery  thereof,  at  any  time  within  three  years  after 
said  return  is  due,  make  a  return  upon  information  obtained  as  above  pro- 
vided for,  and  the  assessment  made  by  the  Commissioner  of  Internal  Revenue 
thereon  shall  be  paid  by  such  corporation,  joint  stock  company  or  association, 
or  insurance  company  immediately  upon  notification  of  the  amount  of  such 
assessment;  and  to  any  sum  or  sums  due  and  unpaid  after  the  thirtieth  day  of 
June  in  any  year,  and  for  ten  days  after  notice  and  demand  thereof  by  the 
collector,  there  shall  be  added  the  sum  of  five  per  centum  on  the  amount  of 
tax  unpaid  and  interest  at  the  rate  of  one  per  centum  per  month  upon  said 
tax  from  the  time  the  same  becomes  due. 

Sixth.  When  the  assessment  shall  be  made,  as  provided  in  this  section, 
the  returns,  together  with  any  corrections  thereof  which  may  have  been  made 
by  the  commissioner,  shall  be  filed  in  the  office  of  the  Commissioner  of 
Internal  Revenue  and  shall  constitute  public  records  and  be  open  to  inspec- 
tion as  such. 

Seventh.  It  shall  be  unlawful  for  any  collector,  deputy  collector,  agent, 
clerk,  or  other  officer  or  employe  of  the  United  States  to  divulge  or  make 
known  in  any  manner  whatever  not  provided  by  law  to  any  person  any  in- 
formation obtained  by  him  in  the  discharge  of  his  official  duty  ,or  to  divulge 
or  make  known  in  any  manner  not  provided  by  law  any  document  received, 
evidence  taken,  or  report  made  under  this  section  except  upon  the  special 
direction  of  the  President;  and  any  offense  against  the  foregoing  provision 
shall  be  a  misdemeanor  and  be  punished  by  a  fine  not  exceeding  one  thousand 
dollars,  or  by  imprisonment  not  exceeding  one  year,  or  both,  at  the  discretion 
of  the  court. 

Eighth.  If  any  of  the  corporations,  joint  stock  companies  or  associations, 
or  insurance  companies  aforesaid,  shall  refuse  or  neglect  to  make  a  return  at 
the  time  or  times  hereinbefore  specified  in  each  year,  or  shall  render  a  false 
or  fraudulent  return,  such  corporation,  joint  stock  company  or  association,  or 
insurance  company,  shall  be  liable  to  a  penalty  of  not  less  than  one  thousand 
dollars  and  not  exceeding  ten  thousand  dollars. 

Any  person  authorized  by  law  to  make,  render,  sign,  or  verify  any  return 
who  makes  any  false  or  fraudulent  return,  or  statement,  with  intent  to  defeat 
or  evade  the  assessment  required  by  this  section  to  be  made,  shall  be  guilty 
of  a  misdemeanor,  and  shall  be  fined  not  exceeding  one  thousand  dollars  or  be 
imprisoned  not  exceeding  one  year,  or  both,  at  the  discretion  of  the  court,  with 
the  costs  of  prosecution. 

All  laws  relating  to  the  collection,  remission,  and  refund  of  internal- 
revenue  taxes,  so  far  as  applicable  to  and  not  inconsistent  with  the  provisions 
of  this  section,  are  hereby  extended  and  made  applicable  to  the  tax  imposed  by 
this  section. 

Jurisdiction  is  hereby  conferred  upon  the  circuit  and  district  courts  of  the 
United  States  for  the  district  within  which  any  person  summoned  under  this 
section  to  appear  to  testify  or  to  produce  books,  as  aforesaid,  shall  reside,  to 
compel  such  attendance,  production  of  books,  and  testimony  by  appropriate 
process. 

Article  I. 

The  attention  of  collectors  and  others  is  specially  called 
to  the  fact  that  the  tax  imposed  by  this  section  of  the  law 


CORPORATION  TAX  REGULATIONS         353 

applies  to  all  corporations,  joint  stock  companies,  associa- 
tions, or  insurance  companies  described  (except  those  spe- 
cifically exempted),  without  reference  to  the  kind  of  busi- 
ness carried  on,  and  that  the  tax  is  to  be  computed  upon 
the  net  income  of  such  corporations,  joint  stock  companies, 
associations,  and  insurance  companies,  which  shall  be  cal- 
culated by  subtracting  from  the  gross  income  received 
from  all  sources  during  the  year  certain  deductions  spe- 
cifically set  forth  in  the  statute. 

Every  corporation,  joint  stock  company,  association, 
or  insurance  company  not  specifically  enumerated  as  ex- 
empt shall  make  the  return  required  by  law,  whether  it 
may  have  net  income  liable  to  tax  or  not.  ^ 

In  the  case  of  corporations,  joint  stock  companies,  as- 
sociations, or  insurance  companies  organized  under  the 
authority  of  the  United  States  or  any  State  or  Territory 
thereof,  including  Alaska  and  District  of  Columbia,  such 
net  income  relates  not  only  to  the  business  carried  on 
within  the  confines  of  the  United  States,  but  to  income 
received  from  business  transacted  in  any  foreign  country 
as  well.  In  case  of  corporations,  joint  stock  companies, 
and  associations  organized  under  the  authority  of  for- 
eign countries  the  terms  ''Gross  income,"  "Net  income," 
and  "Authorized  deductions"  relate  only  to  business  trans- 
acted within  the  United  States  or  any  State  or  Terri- 
tory thereof. 

Article  2.— Gross  income. 

The  following  definitions  and  rules  are  given  for  de- 
termining the  gross  income  of  the  various  classes  of  cor- 
porations : 

lA.  Banks  and  other  Financial  Institutions. — Gross  in- 
come consists  of  the  gross  revenue  derived  from  the  opera- 
tion and  management  of  the  business  and  property  of  the 
corporation  making  the  return,  together  with  all  amounts 
of  income  (including  dividends  received  on  stock  of  other 

B— VIII— 23 


354         CORPORATION  TAX  REGULATIONS 

corporations,  joint  stock  companies,  associations,  and  in- 
surance companies  subject  to  this  tax)  derived  from  all 
other  sources,  as  shown  by  the  entries  on  its  books  from 
January  1  to  December  31  of  the  year  for  which  return 
is  made. 

IB.    Insurance  companies. — Same  as  lA  above. 

2.  Transportation  companies. — Same  as  lA  above. 

3.  Manufacturing  companies. — Gross  income  received 
during  the  year  from  all  sources  will  consist  of  the  total 
amount,  ascertained  through  an  accounting,  that  shows 
the  difference  between  the  price  received  for  the  goods  as 
sold  and  the  cost  of  such  goods  as  manufactured.     The 
cost  of  goods  manufactured  shall  be  ascertained  by  an 
addition  of  a  charge  to  the  account  of  the  cost  of  goods  as 
manufactured  during  the  year  of  the  sum  of  the  inven- 
tory at  beginning  of  the  year  and  a  credit  to  the  accoimt 
of  the  sum  of  the  inventory  at  the  end  of  the  year.    To 
this  amount  should  be  added  all  items  of  income  received 
during  the  year  from  other  sources,  including  dividends 
received  on  stock  of  other  corporations,  joint  stock  com- 
panies, associations,  and  insurance  companies  subject  to 
this  tax.    In  the  determination  of  the  cost  of  goods  manu- 
factured and  sold  as  above  such  cost  shall  comprehend 
all  charges  for  maintenance  and  operation  of  manufactur- 
ing plant,  but  shall  not  embrace  allowances  for  depreci- 
ation of  property  nor  for  losses  sustained  which  are  to  be 
taken  account  of  in  ascertaining  the  net  income  subject  to 
tax  under  the  proper  heading  in  the  authorized  deductions. 
<t   4.    Mercantile  companies.  — Gross  amount  of  income 
received  during  the  year  from  all  sources  consists  of  the 
total  amount  ascertained  through  inventory,  or  its  equiv- 
alent, which  shows  the  difference  between  the  price  re- 
ceived for  goods  sold  and  the  cost  of  goods  purchased  dur- 
ing the  year,  with  an  addition  of  a  charge  to  the  account 
of  the  sum  of  the  inventory  at  beginning  of  the  year  and 
a  credit  to  the  account  of  the  sum  of  the  inventory  at  the 


CORPORATION  TAX  REGULATIONS         355 

end  of  the  year.  To  this  amount  should  be  added  all  items 
of  income  received  during  the  year  from  other  sources 
inclusive  of  dividends  received  on  stock  of  other  corpor- 
ations, joint  stock  companies,  associations,  and  insurance 
companies  subject  to  this  tax.  In  determining  this 
amount,  no  account  shall  be  taken  of  allowances  for  de- 
preciation of  property,  nor  for  losses  sustained  which  are 
to  be  taken  account  of  in  ascertaining  the  net  income  sub- 
ject to  tax  under  the  proper  heading  in  the  authorized 
deductions. 

5.  Miscellaneous. — Gross  income  consists  of  the  gross 
revenue  derived  from  the  operation  and  management  of 
the  business  and  property  of  the  corporation  making  the 
return,  together  with  all  amounts  of  income  (including 
dividends  received  on  stock  of  other  corporations,  joint 
stock  companies,  associations,  and  insurance  companies 
subject  to  this  tax)  derived  from  all  other  sources  as  shown 
by  the  entries  on  the  books  from  January  1  to  December  31 
of  the  year  for  which  return  is  made. 

It  will  be  noted  from  these  definitions  that  gross  in- 
come is  practically  the  same  as  gross  profits,  the  only  dif- 
ference being  that  gross  income  is  more  inclusive,  embrac- 
ing as  it  does  not  only  gross  profits  of  the  corporation, 
joint  stock  company,  and  association  itself,  but  also  all 
amounts  of  income  received  from  other  sources.  It  is  im- 
material whether  any  item  of  gross  income  is  evidenced 
by  cash  receipts  during  the  year  or  in  such  other  manner 
as  to  entitle  it  to  proper  entry  on  the  books  of  the  corpora- 
tion from  January  1  to  December  31  for  the  year  in  which 
return  is  made. 

Sale  of  capital  assets. — ^In  ascei^taining  income  derived 
from  the  sale  of  capital  assets,  if  the  assets  were  acquired 
subsequent  to  January  1,  1909,  the  difference  between  the 
selling  price  and  the  bujdng  price  sKall  constitute  an  item 
of  gross  income  to  be  added  to  or  subtracted  from  gross 
income  according  to  whether  the  selling  price  was  greater 


356         CORPORATION  TAX  REGULATIONS 

or  less  than  the  buying  price.  If  the  capital  assets  were 
acquired  prior  to  January  1,  1909,  the  amount  of  incre- 
ment or  depreciation  representing  the  difference  between 
the  selling  and  buying  price  is  to  be  adjusted  so  as  to  fair- 
ly determine  the  proportion  of  the  loss  or  gain  arising  sub- 
sequent to  January  1,  1909,  and  which  proportion  shall  be 
deducted  from  or  added  to  the  gross  income  for  the  year 
in  which  the  sale  was  made.  But  for  the  purpose  of  de- 
termining the  selling  price,  as  provided  in  this  section, 
there  shall  be  added  to  the  price  actually  realized  on  sale 
any  amount  which  has  already  been  set  aside  and  de- 
ducted from  gross  income  by  way  of  depreciation  as  de- 
fined in  article  4  and  has  not  been  paid  out  in  making 
good  such  depreciation  on  the  property  sold. 

Where  a  corporation  is  engaged  in  carrying  on  more 
than  one  class  of  business,  gross  income  derived  from  the 
different  classes  of  business  shall  be  ascertained  accord- 
ing to  the  definitions  above  applicable  thereto. 

Article  3. — Net  income. 

Net  income  shall  be  ascertained  by  deducting  from  the  gross  amount  of 
the  income  of  such  corporation,  joint  stock  company  or  association,  or 
insurance  company,  received  within  the  year  from  all  sources,  (first)  all  the 
ordinary  and  necessary  expenses  actually  paid  within  the  year  out  of  income 
in  the  maintenance  and  operation  of  its  business  and  properties,  including  all 
charges  such  as  rentals  or  franchise  payments,  required  to  be  made  as  a 
condition  to  the  continued  use  or  possession  of  property;  (second)  all  losses 
actually  sustained  within  the  year  and  not  compensated  by  insurance  or  other- 
wise, including  a  reasonable  allowance  for  depreciation  of  property,  if  any,  and 
in  the  case  of  insurance  companies  the  sums  other  than  dividends  paid  within 
the  year  on  policy  and  annuity  contracts  and  the  net  addition,  if  any,  re- 
quired by  law  to  be  made  within  the  year  to  reserve  funds;  (third)  interest 
actually  paid  within  the  year  on  its  bonded  or  other  indebtedness  to  an 
amount  of  such  bonded  and  other  mdebtedness  not  exceeding  the  paid-up 
capital  stock  of  such  corporation,  joint  stock  companv  or  association,  or 
insurance  company,  outstanding  at  the  close  of  *he  year,  and  in  the  case  of  a 
bank,  banking  association,  or  trust  company,  all  interest  actually  paid  by  it 
within  the  year  on  deposits.  [In  case  of  corporations,  joint  stock  companies, 
and  associations  organized  under  the  laws  of  a  foreign  country,  "the  propor- 
tion of  its  paid-up  capital  stock  outstanding  at  the  close  of  the  year  which  the 
gross  amount  of  its  income  for  the  year  from  business  transacted  and  capital 
invested  within  the  United  States  and  any  of  its  Territories,  Alaska,  and  the 
Pistjict  of  Columbia  bears  to  thp  f^ross  amount  of  its  income  derived  from 


CORPORATION  TAX  REGULATIONS         357 

all  sources  within  and  without  the  United  States"]  ;*  (fourth)  all  sums  paid 
by  it  within  the  year  for  taxes  imposed  under  the  authority  of  the  United 
States  or  of  any  State  or  Territory  thereof,  or  imposed  by  the  government  of 
any  foreign  country  as  a  condition  to  carrying  on  business  therein;  (fifth)  all 
amounts  received  by  it  within  the  year  as  dividends  upon  stock  of  other 
corporations,  joint  stock  companies  or  associations,  or  insurance  companies, 
subject  to  the  tax  hereby  imposed. 

Section  38  further  provides: 

That  in  the  case  of  a  corporation,  joint  stock  company  or  association,  or 
insurance  company,  organized  under  the  laws  of  a  foreign  country,  such  net 
income  shall  be  ascertained  (by  making  like  deductions)  from  the  gross 
amount  of  its  income  received  within  the  year  from  business  transacted  and 
its  capital  invested  within  the  United  States  and  any  of  its  Territories,  Alaska, 
and  the  District  of  Columbia. 

Also  that: 

In  the  case  of  assessment  insurance  companies  the  actual  deposit  of  sums 
with  state  or  territorial  officers,  pursuant  to  law,  as  additions  to  guaranty 
or  reserve  fund,  shall  be  treated  as  being  payments  required  by  law  to  re- 
serve fund. 

Also  (third  paragraph)  that: 

There  shall  be  deducted  from  the  amount  of  the  net  income  of  each  of 
such  corporations,  joint  stock  companies  or  associations,  or  insurance  com- 
panies, ascertained  as  provided  in  the  foregoing  paragraphs  of  this  section, 
the  sum  of  five  thousand  dollars. 

The  net  income,  therefore,  is  the  remainder  of  the  gross 
Income  after  making  the  specified  deductions. 

Article  4. — ^Deductions. 

The  specified  deductions  actually  paid  within  the  year, 
eet  forth  in  the  statute  and  as  described  in  article  3  pre- 
ceding, shall  include  all  proper  items  of  expenses  and 
charges  under  the  respective  heads  as  designated.  The 
amount  returned  for  ordinary  and  necessary  expenses 
actually  paid  within  the  year  out  of  income  in  maintenance 
and  operation  of  the  business  and  properties  of  the  corpora- 
tion should  not,  however,  embrace  allowances  for  deprecia- 
tion of  fixed  property  which  are  otherwise  to  be  taken 
account  of  under  the  proper  heading  in  the  authorized  de- 
ductions, nor  expenses  paid  within  the  year  and  charged 

*  The  matter  included  in  brackets  [  ]  relates  to  interest  actually  paid  with- 
in the  year  on  "bonded  or  other  indebtedness,"  and  should  be  read  in  con- 
nection with  the  preceding  provision  (art.  3)  relating  to  such  interest  paid 
by  corporations,  joint  stock  companies,  etc.,  organized  in  the  United  States. 


358         CORPORATION  TAX  REGULATIONS 

to  sueli  allowances  for  depreciation  credited  in  the  current 
year  or  in  iDrevious  years.  In  ascertaining  expenses  proper 
to  be  included  in  the  deductions  to  be  made  under  this 
article,  corporations  carrying  materials  and  supplies  on 
hand  for  use  should  include  in  such  expenses  the  charges 
for  materials  and  supplies  only  to  the  amount  that  the  same 
are  actually  disbursed  and  used  in  operation  and  main- 
tenance during  the  year  for  which  the  return  is  made. 

It  is  immaterial  whether  the  deductions  are  evidenced! 
by  actual  disbursements  in  cash,  or  whether  evidenced  in 
such  other  way  as  to  be  properly  acknowledged  by  the 
corporate  officers  and  so  entered  on  the  books  as  to  consti- 
tute a  liability  against  the  assets  of  the  corporation,  joint 
stock  company,  association,  or  insurance  company  making 
the  return. 

Losses. — The  deduction  for  losses  must  be  in  respect 
of  losses  actually  sustained  during  the  year  and  not  com- 
pensated by  insurance  or  otherwise.  It  must  be  based  upon 
the  difference  between  the  cost  value  and  salvage  value 
of  the  property  or  assets,  including  in  the  latter  value  such 
amount,  if  any,  as  has  in  the  current  or  pre^dous  years 
been  set  aside  and  deducted  from  gross  income  by  way  of 
depreciation  as  defined  in  the  following  section  and  not 
been  paid  out  in  making  good  such  depreciation. 

'  Depreciation. — The  deduction  for  depreciation  should 
be  the  estimated  amount  of  the  loss,  accrued  during  the 
year  to  which  the  return  relates,  in  the  value  of  the  prop- 
erty in  respect  of  which  such  deduction  is  claimed  that 
arises  from  exhaustion,  wear  and  tear,  or  obsolescence  out 
of  the  uses  to  which  the  property  is  put,  and  which  loss 
has  not  been  made  good  by  payments  for  ordinary  main- 
tenance and  repairs  deducted  under  the  heading  of  expens- 
es of  maintenance  and  operation  or  in  the  ascertainment 
of  gross  income.  This  estimate  should  be  formed  upon 
the  assumed  life  of  the  property,  its  cost  value,  and  its 
use.    Expenses  paid  in  any  one  ye'ar  in  making  good  ex- 


CORPORATION  TAX  REGULATIONS         359 

hanstion,  wear  and  tear,  or  obsolescence  in  respect  of  which 
any  deduction  for  depreciation  is  claimed  must  not  be 
included  in  the  deduction  for  expense  of  maintenance  and 
operation  of  the  property  or  in  the  ascertainment  of  gross 
income,  but  must  be  made  out  of  accumulative  allowances 
deducted  for  depreciation  in  current  and  previous  years. 

Article  5. — Inventories. 

It  will  be  noted  that  an  inventory  or  its  equivalent  of 
materials,  supplies,  and  merchandise  on  hand  for  use 
or  sale  at  the  close  of  each  calendar  year  is  essential  in 
the  case  of  certain  corporations  in  order  to  determine  the 
gross  income,  and  in  case  of  other  corporations  to  deter- 
mine their  expenses  of  operation.  Wliere  such  inventory 
or  its  equivalent  was  not  taken  at  the  close  of  the  year  1908, 
a  supplemental  statement  showing  such  inventory  approx- 
imately must  be  submitted  with  the  return  on  the  regular 
form.  Such  supplemental  statement  shall  be  verified  under 
oath  by  the  treasurer  or  principal  financial  officer  in  sub- 
mitting the  same. 

Where  any  item  under  any  of  the  deductions  is  of  an 
unusual  nature  a  special  explanatory  note  referring  to  such 
item  shall  be  made  and  attached  to  the  form  at  the  appro- 
priate 23lace  and  made  a  part  thereof  by  proper  reference. 

Paragraph  3  of  said  section  38  also  provides: 

And  said  tax  shall  be  computed  upon  the  remainder  of  said  net  income  ®f 
such  corporation,  joint  stock  company  or  association,  or  insurance  company, 
for  the  year  ending  December  thirty-first,  nineteen  hundred  and  nine,  and 
for  each  calendar  year  thereafter;  and  on  or  before  the  first  day  of  March, 
nineteen  hundred  and  ten,  and  the  first  day  of  March  in  each  year  thereafter, 
a  true  and  accurate  return  under  oath  or  affirmation  of  its  president,  vice- 
president,  or  other  principal  officer,  and  its  treasurer  or  assistant  treasurer, 
shall  be  made  by  each  of  the  corporations,  joint  stock  companies  or  as- 
sociations, and  insurance  companies,  subject- to  the  tax  imposed  by  this  sec- 
tion, to  the  collector  of  internal  revenue  for  the  district  in  which  such  corpora- 
tion, joint  stock  company  or  association,  or  insurance  company,  has  its 
principal  place  of  business,  or,  in  the  case  of  a  corporation,  joint  stock  com- 
pany or  association,  or  insurance  company,  organized  under  the  laws  of  a 
foreign  country,  in  the  place  where  its  principal  business  is  carried  on  within 
the  United  States,  in  such  form  as  the  Commissioner  of  Internal  Revenue, 
with  the  approval  of  the  Secretary  of  the  Treasury,  shall  prescribe. 


S60         COEPORATION  TAX  REGULATIONS 

Each  return  so  made  is  required  to  set  forth: 

(a)  The  total  amount  of  the  paid-up  capital  stock  of 
such  corporations,  joint  stock  companies  or  associations, 
or  insurance  companies,  outstanding  at  the  close  of  the 
year; 

(b)  The  total  amount  of  bonded  and  other  indebted- 
ness of  such  corporation,  joint  stock  company  or  associa- 
tion, or  insurance  company,  at  the  close  of  the  j^ear; 

(c)  The  gross  amount  of  the  income  of  such  corpora- 
tion, joint  stock  company  or  association,  or  insurance  com- 
pany, received  during  the  year  from  all  sources,  and  if 
organized  under  the  laws  of  a  foreign  country,  the  gross 
amount  of  its  income  received  within  the  year  from  busi- 
ness transacted  and  capital  invested  within  the  United 
States  and  any  of  its  Territories,  Alaska,  and  the  District 
of  Columbia. 

Such  returns  are  also  required  to  set  forth  the  items 
claimed  as  deductions  (Article  4),  also  the  net  income  after 
such  deductions  have  been  made. 

Article  6. 

Under  the  authority  conferred  by  this  act  forms  of  re- 
turn have  been  prescribed,  in  which  the  various  items  spe- 
cified in  the  law  are  to  be  stated. 

Blank  forms  of  this  return  will  be  mailed  to  collectors 
and  should  be  furnished  to  every  corporation,  not  express- 
ly excepted,  on  or  before  January  1,  1910,  and  on  or  be- 
fore January  1st  of  each  year  thereafter.  Failure  on  the 
part  of  any  corporation,  joint  stock  company,  association, 
or  insurance  company  liable  to  this  tax,  to  receive  a  blank 
form  will  not  excuse  it  from  making  the  return  required 
by  law,  or  relieve  it  from  any  penalties  for  failure  to  make 
the  return  in  the  prescribed  time.  Corporations  not  sup- 
plied with  the  proper  forms  for  making  the  return  should 
make  application  therefor  to  the  collector  of  internal  rev- 
enue in  whose  district  is  located  its  principal  place  of  busi- 


CORPORATION  TAX  REGULATIONS         361 

ness.  Each  corporation  should  carefully  prepare  its  return 
so  as  to  fully  and  clearly  set  forth  the  data  therein  called 
for. 

Bookkeeping. — ^No  particular  system  of  bookkeeping  or 
accounting  will  be  required  by  the  department.  However, 
the  business  transacted  by  corporations,  joint  stock  com- 
panies, associations,  or  insurance  companies  must  be  so 
recorded  that  each  and  every  item  therein  set  forth  may 
be  readily  verified  by  an  examination  of  the  books  and  ac- 
counts, where  such  examination  is  deemed  necessary. 

Calendar  Year. — As  the  law  specifically  provides  that 
the  tax  imposed  shall  be  computed  on  the  net  income  dur- 
ing each  "calendar  year,"  returns  of  income  based  on  any 
period  other  than  the  calendar  year  cannot  be  accepted. 

Corporations  organized  during  the  year  or  going  into 
liquidation  during  the  year  should  nevertheless  render  a 
sworn  return  on  the  prescribed  form. 

Article  7. 

Collectors  will  see  that  as  soon  as  each  return  made 
by  any  corporation  is  received  a  record  on  Form  632  is 
made,  setting  out  the  name  of  the  corporation  making  the 
return,  the  nature  of  the  principal  business  transacted,  the 
location  of  principal  place  of  business,  with  net  income  re- 
ported, and  the  date  on  which  such  return  was  received. 
The  date  of  receipt  in  each  case  will  be  noted  in  the  last 
column  of  that  form,  in  which  column  the  list  on  which 
assessment  is  made  will  also  be  noted.  For  this  purpose 
the  column  so  used  may  be  subdivided,  or  the  date  of  re- 
ceipt of  such  returns  may  be  noted  in  red  ink  over  the  date 
entered  therein  as  to  such  assessment  list. 

-*  Any  collector  will,  whenever  it  appears  advisable  to 
do  so,  request  that  a  revenue  agent  be  specially  designated 
to  collect  and  furnish  this  office  with  such  other  data  as, 
in  his  judgment,  is  necessary  to  determine  the  actual 
amount  of  tax  to  be  assessed  against  any  corporation,  joint 


362        CORPORATION  TAX  REGULATIONS 

stock  company,  or  association  which  under  the  law  set  forth 
in  these  regulations  is  required  to  make  return. 

Such  returns  are  required  to  be  made  not  later  than 
March  1  of  each  year,  and  any  failure  to  comply  with  the 
law  in  this  regard  should  be  at  once  reported  by  the  col- 
lector to  the  Commissioner  of  Internal  Revenue. 

To  enable  collectors  to  determine  whether  all  returns 
due  have  been  received,  a  careful  canvass  of  each  district 
should  be  made,  and  all  corporations,  joint  stock  companies, 
and  associations  subject  to  the  tax  imposed  should  be 
listed  as  above  directed. 

Article  8. 

For  statistical  purposes  such  corporations,  joint  stock 
companies,  and  associations  are  classified  as  follows: 

Class  A:  Financial  and  Commercial. — Including  banks, 
banking  associations,  trust  companies,  guaranty  and  surety 
companies,  title  insurance  companies,  building  associa- 
tions (if  for  profit),  and  insurance  companies,  not  spe- 
cifically exempt. 

Class  B:  Public  Service. — Such  as  railroads,  steamboat, 
ferryboat,  and  stage-line  companies;  pipe-line,  gas,  and 
electric-light  companies;  express,  transportation,  and  stor- 
age companies;  telegraph  and  telephone  companies. 

Class  C:  Industrial  and  Manufacturing. — Such  as  min- 
ing, lumber,  and  coke  companies;  rolling  mills;  foundry 
and  machine  shops;  sawmills;  flour,  woolen,  cotton,  and 
other  mills;  manufacturers  of  cars,  automobiles,  elevators, 
agricultural  implements,  and  all  articles  manufactured 
wholly  or  in  part  from  metal,  wood,  or  other  material;  man- 
ufacturers or  refiners  of  sugar,  molasses,  syrups,  or  other 
products ;  ice  and  refrigerating  companies ;  slaughterhouse, 
tannery,  packing,  or  canning  companies,  etc. 

Class  D:  Mercantile. — Including  all  dealers  (not  other- 
wise classed  as  producers  or  manufacturers)  in  coal,  lum- 
ber, grain,  produce,  and  all  goods,  wares,  and  merchandise. 


CORPORATION  TAX  REGULATIONS         363 

Class  E:  Miscellaneous. — Sucli  as  architects,  contractors, 
hotel,  theater,  or  other  companies,  or  associations,  not 
otherwise  classed. 

When  classified  as  above  indicated  the  names  of  the 
various  corporations,  companies,  and  associations  will  be 
listed  alphabetically,  and  will  be  numbered  consecutively 
(commencing  with  No.  1  in  each  class),  and  in  forwarding 
returns  or  papers  subsequently  rendered  or  submitted  by 
such  corporations  or  companies  collectors  will  see  that  the 
same  have  placed  thereon  the  designating  class  letter  and 
number  corresponding  with  those  noted  on  the  lists  herein 
required  to  be  furnished. 

Article  9. — Examination  of  Books,  etc.,  by 
Revenue  Agents. 

Paragraph  4  of  said  section  38  provides: 

Fourth.  Whenever  evidence  shall  be  produced  before  the  Commissioner 
of  Internal  Revenue  which  in  the  opinion  of  the  Commissioner  justifies  the 
belief  that  the  return  made  by  any  corporation,  joint  stock  company  ©r  as- 
sociation, or  insurance  company,  is  incorrect,  or  whenever  any  collector  shall 
report  to  the  Commissioner  of  Internal  Revenue  that  any  corporation,  joint 
stock  company  or  association,  or  insurance  company,  has  failed  to  make  a 
return  as  required  by  law,  the  Commissioner  of  Internal  Revenue  may  require 
from  the  corporation,  joint  stock  company  or  association,  or  insurance  com- 
pany making  such  return,  such  further  information  with  reference  to  its 
capital,  income,  losses,  and  expenditures  as  he  may  deem  expedient;  and  the 
Commissioner  of  Internal  Revenue,  for  the  purpose  of  ascertaining  the  cor- 
rectness of  such  return  or  for  the  purpose  of  making  a  return  where  none 
has  been  made,  is  hereby  authorized,  by  any  regularly  appointed  revenue 
agent  specially  designated  by  him  for  that  purpose,  to  examine  any  books 
and  papers  bearing  upon  the  matters  required  to  be  included  in  the  return 
of  such  corporation,  joint  stock  company  or  association,  or  insurance  com- 
pany, and_  to  require  the  attendance  of  any  officer  or  employe  of  such  cor- 
poration, joint  stock  company  or  association,  or  insurance  company,  and  to 
take  his  testimony  with  reference  to  the  matter  required  by  law  to  be  in- 
cluded in  such  return,  with  power  to  administer  oaths  to  such  person  or 
persons;  and  the  Commissioner  of  Internal  Revenue  may  also  invoke  the 
aid  of  any  court  of  the  United  States  having  jurisdiction  to  require  the  at- 
tendance of  such  officers  or  employes  and  the  production  of  such  books 
and  papers.  Upon  the  information  so  acquired  the  Commissioner  of  Internal 
Revenue  may  amend  any  return  or  make  a  return  where  none  has  been 
made.  All  proceedings  taken  by  the  Commissioner  of  Internal  Revenue  under 
the  provisions  of  this  section  shall  be  subject  to  the  approval  of  the  Secretary 
of  the  Treasury. 


364         CORPORATION  TAX  REGULATIONS 

Article  10. — Assessment  and  Collection  of  Tax,  etc. 

Paragrapli  5  of  said  section  38  provides : 

Fifth,  All  returns  shall  be  retained  by  the  Commissioner  of  Internal 
Revenue,  who  shall  make  assessments  thereon;  and  in  case  of  any  return 
made  with  false  or  fraudulent  intent,  he  shall  add  one  hundred  per  centum  of 
such  tax,  and  in  case  of  a  refusal  or  neglect  to  make  a  return  or  to  verify  the 
same  as  aforesaid  he  shall  add  fifty  per  centum  of  such  tax.  In  case  of 
neglect  occasioned  by  the  sickness  or  absence  of  an  officer  of  such  corpora- 
tion, joint  stock  company  or  association,  or  insurance  company,  required 
to  make  said  return,  or  for  other  sufficient  reason,  the  collector  may  allow 
such  further  time  for  making  and  delivering  such  return  as  he  may  deem 
necessary,  not  exceeding  thirty  days.  The  amount  so  added  to  the  tax  shall 
be  collected  at  the  same  time  and  in  the  same  manner  as  the  tax  originally 
assessed  unless  the  refusal,  neglect,  or  falsity  is  discovered  after  the  date  for 
payment  of  said  taxes,  in  which  case  the  amount  so  added  shall  be  paid  by 
the  delinquent  corporation,  joint  stock  company  or  association,  or  insurance 
company  immediately  upon  notice  given  by  the  collector.  All  assessments 
shall  be  made  and  the  several  corporations,  joint  stock  companies  or  as- 
sociations, or  insurance  companies,  shall  be  notified  of  the  amount  for  which 
they  are  respectively  liable  on  or  before  the  first  day  of  June  of  each  suc- 
cessive year,  and  said  assessments  shall  be  paid  on  or  before  the  thirtieth 
day  of  June,  except  in  cases  of  refusal  or  neglect  to  make  such  return,  and 
in  cases  of  false  or  fraudulent  returns,  in  which  cases  the  Commissioner  of 
Internal  Revenue  shall,  upon  the  discovery  thereof,  at  any  time  within  three 
years  after  said  return  is  due,  make  a  return  upon  information  obtained  as 
above  provided  for,  and  the  assessment  made  by  the  Commissioner  of  Internal 
Revenue  thereon  shall  be  paid  by  such  corporation,  joint  stock  company  or 
association,  or  insurance  company  immediately  upon  notification  of  the  amount 
of  such  assessment;  and  to  any  sum  or  sums  due  and  unpaid  after  the 
thirtieth  day  of  June  in  any  year,  and  for  ten  days  after  notice  and  demand 
thereof  bj'-  the  collector,  there  shall  be  added  the  sum  of  five  per  centum  on 
the  amount  of  tax  unpaid  and  interest  at  the  rate  of  one  per  centum  per 
month  upon  said  tax  from  the  time  the  same  becomes  due. 

Upon  the  receipt  and  verification  of  the  returns  ren- 
dered, the  tax  as  ascertained  to  be  due  will  be  assessed 
as  above  prescribed;  and  notice  of  such  assessment  will 
be  given  and  subsequent  demand  made  (if  necessary)  on 
Forms  17  and  21,  respectively. 

In  case  of  failure  to  make  returns  within  the  time  and 
manner  required  by  the  statute,  or  where  the  return  ren- 
dered is  found  or  believed  to  be  incorrect,  action  in  such 
cases  will  be  taken,  as  provided  in  paragraph  4  of  the  law. 

The  additional  tax  imposed  by  paragraph  5  of  the  law 
for  failure  to  make  the  required  return,  or  for  making  a 
false  or  fraudulent  return,  will  in  all  cases  be  assessed  as 
therein  provided. 


CORPORATION  TAX  REGULATIONS         36S 

Article  11. — Returns  to  Constitute  Public  Records. 

Paragraph  6  of  said  section  38  provides: 

Sixth.  When  the  assessment  shall  be  made,  as  provided  in  this  section, 
the  returns,  together  with  any  corrections  thereof  which  may  have  been 
made  by  the  commissioner,  shall  be  filed  in  the  office  of  the  Commissioner  of 
Internal  Revenue  and  shall  constitute  public  records  and  be  open  to  inspection 
as  such. 

Article  12. — Penalties. 

Paragraphs  7  and  8  of  section  38  provide: 

Seventh.  It  shall  be  unlawful  for  any  collector,  deputy  collector,  agent, 
clerk,  or  other  ofiicer  or  employe  of  the  United  States  to  divulge  or  make 
known  in  any  manner  whatever  not  provided  by  law  to  any  person  any  in- 
formation obtained  by  him  in  the  discharge  of  his  official  duty,  or  to  divulge 
or  make  known  in  any  manner  not  provided  by  law  any  document  received, 
evidence  taken,  or  report  made  under  this  section  except  upon  the  special 
direction  of  the  President;  and  any  offense  against  the  foregoing  provision 
shall  be  a  misdemeanor  and  be  punished  by  a  fine  not  exceeding  one  thous- 
and dollars,  or  by  imprisonment  not  exceeding  one  year,  or  both,  at  the 
discretion  of  the  court. 

Eighth.  If  any  of  the  corporations,  joint  stock  companies  or  associations, 
or  insurance  companies,  aforesaid,  shall  refuse  or  neglect  to  make  a  return 
at  the  time  or  times  hereinbefore  specified  in  each  year,  or  shall  render  a 
false  or  fraudulent  return,  such  corporation,  joint  stock  company  or  as- 
sociation, or  insurance  company,  shall  be  liable  to  a  penalty  of  not  less  than 
one  thousand  dollars  and  not  exceeding  ten  thousand  dollars. 

Any  person  authorized  by  law  to  make,  render,  sign,  or  verify  any  return 
who  makes  any  false  or  fraudulent  return,  or  statement,  with  intent  to  de- 
feat or  evade  the  assessment  required  by  this  section  to  be  made,  shall  be 
guilty  of  a  misdemeanor,  and  shall  be  fined  not  exceeding  one  thousand  dol- 
lars or  be  imprisoned  not  exceeding  one  year,  or  both,  at  the  discretion  of 
the  court,  with  the  costs  of  prosecution. 

Article  13. — Certain  Revenue  Laws  Made  Applicable,  and 

Jurisdiction  Conferred  on  United  States  Courts  to 

Compel  Attendance  of  Witnesses,  etc. 

Paragraph  8  further  provides: 

All  laws  relating  to  the  collection,  remission,  and  refund  of  internal- 
revenue  taxes,  so  far  as  applicable  to  and  not  inconsistent  with  the  provisions 
of  this  section,  are  hereby  extended  and  made  applicable  to  the  tax  imposed 
by  this  section. 

Jurisdiction  is  hereby  conferred  upon  the  circuit  and  district  courts  of  the 
United  States  for  the  district  within  which  any  person  summoned  under  this 
section  to  appear  to  testify  or  to  produce  books,  as  aforesaid,  shall  reside,  to 
compel  such  attendance,  production  of  books,  and  testimony  by  appropriate 
process. 

Article  14. — Collection  of  Tax. 

The  tax  assessed  under  the  provisions  of  this  act  will 
be  collected  and  will  be  receipted  for  on  Form  1,  as  in  the 


366         CORPORATION  TAX  REGULATIONS 

case  of  other  assessed  taxes.  Unless  paid  within  the  time 
fixed  by  the  statute,  notice  and  demand  should  be  at  once 
issued,  and,  in  case  of  nonpayment,  distraint  proceedings 
should  be  instituted  without  delay. 


THE  FEDERAL  CORPORATION  TAX  AND 
MODERN  ACCOUNTING  PRACTICE  * 

BY  A.  M.  SAKOLSKI. 

It  is  not  "uncommon  in  these  days  for  legislatures  to 
enact  revenue  measures  in  utter  disregard  of  modern 
accounting  principles.  Unfortunately  accounting  terminol- 
ogy is  frequently  employed  in  tax  legislation  without 
reference  to  the  proper  meaning  as  applied  in  business 
practice.  In  the  tax  laws  of  many  of  the  states,  for  ex- 
ample, 'intangible  assets"  are  defined  as  stocks,  bonds, 
mortgages  and  other  forms  of  securities,  whereas  in  ac- 
counting practice  the  same  term  represents  merely  the 
*' good-will,  franchises,  patent  rights,"  etc.,  of  a  business. 
The  definitions  of  ''gross  earnings,"  "profits,"  "income," 
*' revenue,"  "capital,"  etc.,  are  likewise  frequently  applied 
in  taxation  in  a  sense  differing  from  the  meaning  ordinarily 
attached  thereto  by  accountants.  Disagreement  and  con- 
fusion in  the  use  of  accounting  terms  is  common  to  much 
of  the  legislation  relating  to  corporations.  Moreover,  the 
decisions  of  both  ths  federal  and  the  state  courts  as  to 
the  proper  interpretation  of  accounting  terms  are  exceed- 
ingly unsatisfactory  and  in  many  cases  incompatible  with 
business  practice.  Any  attempt  to  harmonize  them  into  a 
set  of  general  rules  and  principles  appears  a  hopeless  task. 
At  one  time  the  Supreme  Court  of  the  United  Statesf 
decided  that  "profits"  are  merely  receipts  over  expendi- 
tures with  no  consideration  given  to  depreciation.  Other 
court  decisions  hold  a  contrary  view,  some  agreeing  to 
the  established  accounting  principle  that  net  profits  are 

*  From  Yale  Review,  February,  1910.  Reprinted  by  permission  of  the 
editors  of  the  Review  and  by  courtesy  of  Dr.  Sakolski. 

fEyster  v.  Centennial  Board  of  Finance,  94  U.  S.,  p.  503. 

367 


368  A.  M.  SAKOLSKI 

not  finally  deteimined  until  all  losses  due  to  waste,  depre- 
ciation and  obsolescence  of  both  fixed  and  circulating  assets 
are  made  good. 

In  view  of  the  confusion  existing  in  the  definition  and 
use  of  accounting  terms  by  legislatures  and  the  law  courts, 
the  recently  enacted  federal  corporation  tax  law  might 
be  expected  to  meet  with  condemnation  and  disapproval 
on  the  part  of  business  men  and  accountants.  On  July  8, 
1909,  just  previous  to  the  final  passage  of  the  Act,  a  num- 
ber of  the  leading  accounting  firms  addressed  a  letter  to 
the  Attorney-General  calling  attention  to  the  radical  de- 
fects of  the  measure,  which  they  characterized  as  impos- 
sible of  application  and  utterly  out  of  harmony  with 
modern  accounting  practice.  The  important  provisions  of 
the  law  to  which  objections  have  been  raised  are  as  follows: 

Sec.  38.  That  every  corporation,  joint  stock  company  or  association, 
organized  for  profit  and  having  a  capital  stock  represented  by  shares,  and 
every  insurance  company,  now  or  hereafter  organized  under  the  laws  of  the 
United  States  or  of  any  State  or  Territory  of  the  United  States  or  under 
the  acts  of  Congress  applicable  to  Alaska  or  the  District  of  Columbia,  or 
now  or  hereafter  organized  under  the  laws  of  any  foreign  country  and 
engaged  in  business  in  any  State  or  Territory  of  the  United  States  or  in 
Alaska  or  in  the  District  of  Columbia,  shall  be  subject  to  pay  annually  a 
special  excise  tax  with  respect  to  the  carrying  on  or  doing  business  by  such 
corporation,  joint  stock  company  or  association,  or  insurance  company,  equiv- 
alent to  one  per  centum  upon  the  entire  net  income  over  and  above  five 
thousand  dollars  received  by  it  from  all  sources  during  such  year,  exclusive 
of  amounts  received  by  it  as  dividends  upon  stock  of  other  corporations,  joint 
stock  companies  or  associations,  or  insurance  companies,  subject  to  the  tax 
hereby  imposed;     .... 

.  .  .  Such  net  income  shall  be  ascertained  by  deducting  from  the  gross 
amount  of  the  income  of  such  corporation,  joint  stock  company  or  associa- 
tion, or  insurance  company,  received  within  the  year  from  all  sources,  (first) 
all  the  ordinary  and  necessary  expenses  actually  paid  within  the  year  out  of 
income  in  the  maintenance  and  operation  of  its  business  and  properties,  in- 
cluding all  charges  such  as  rentals  or  franchise  payments,  required  to  be 
made  as  a  condition  to  the  continued  use  or  possession  of  property;  (second) 
all  losses  actually  sustained  within  the  year  and  not  compensated  by  in- 
surance or  otherwise,  including  a  reasonable  allowance  for  depreciation  of 
property,  if  any,  and  in  the  case  of  insurance  companies  the  sums  other  than 
dividends,  paid  within  the  year  on  policy  and  annuity  contracts  and  the  net 
addition,  if  any,  required  by  law  to  be  made  within  the  year  to  reserve  funds; 
(third)  interest  actually  paid  within  the  year  on  its  bonded  or  other  indebted- 
ness to  an  amount  of  such  bonded  and  other  indebtedness  not  exceeding  the 
paid-up  capital  stock  of  such  corporation,  joint  stock  company  or  association, 
or  insurance  company,  outstanding  at  the  close  of  the  year,  and  in  the  case 
of  a  bank,  banking  association  or  trust  company,  all  interest  actually  paid  by- 
it  within  the  year  on  deposits;     .    . 


THE  FEDERAL  CORPORATION  TAX         369> 

Aside  from  the  protest  against  the  requirement  that 
the  tax  return  cover  the  calendar  year,  the  principal  criti- 
cism of  the  measure  from  an  accounting  view-point  is  di- 
rected against  the  phraseology  defining  ^ '  net  income. ' '  The 
language  of  the  Act  is  so  crude  and  the  definitions  so  ab- 
surd and  so  contrary  to  accepted  principles  of  accounting 
that  it  has  been  justly  condemned  as  applicable  only  to 
the  bookkeeping  methods  of  the  Middle  Ages.  The  defects 
can  be  ascribed  to  hasty  and  careless  legislation.  Mem- 
bers of  Congress,  with  but  few  exceptions,  were  utterly 
indifferent  to  the  provisions  of  the  bill,  the  belief  prevail- 
ing that  when  handled  by  the  executive  and  judicial 
branches  of  the  Government,  the  measure  would  reach 
some  final  adjustment,  or  more  likely,  complete  extinguish- 
ment. The  official  interpretation  of  the  provisions  con- 
cerns us  more  than  the  language  of  the  Act  itself. 

In  the  letter  of  the  accountants  addressed  to  the  At- 
torney-General, the  objections  to  the  proposed  tax  were 
shown  to  center  about  the  provision  requiring  ''net  income" 
to  be  ascertained  by  deducting  from  the  gross  amount  of 
income  received,  expenses  actually  paid,  losses  actually 
sustained  and  interest  actually  paid.  The  use  of  the  ex- 
pressions "actually  paid"  and  "actually  sustained"  in  the 
calculation  of  net  income  naturally  created  consternation 
among  the  accounting  profession.  Modem  accounting, 
especially  as  regards  the  determination  of  net  profits,  rests 
upon  the  principle  that  "income"  is  to  be  distinguished 
from  "receipts"  and  "expenses"  from  "disbursements." 
Prior  to  the  advent  of  the  corporate  form  of  business 
organization,  bookkeeping  was  concerned  almost  exclusive- 
ly with  tracing  out  the  movements  of  cash.  The  accounts 
showed  the  amounts  and  the  sources  of  cash  received  and 
the  manner  in  which  it  was  disbursed.  The  main  purpose 
of  the  early  accounting  methods  was  the  testing  of  the 
honesty  of  the  employes  handling  cash.  The  gauging  of 
the  proprietors '  profits  or  the  results  of  individual  transac- 

B— VIII— 24 


370  A.  M.  SAKOLSKI 

tions  was  of  secondary  importance.  In  modem  times  this 
condition  is  reversed.  Present  day  accounting  aims  to  ex- 
hibit in  correct  and  intelligible  form  the  net  gain  or  loss 
of  business  operations  independent  of  the  movements  of 
cash  therein.  The  tracing  of  the  actual  receipts  and  the 
actual  disbursements  of  cash,  though  an  important  part 
of  every  accounting  system,  has  no  direct  relation  to  the 
results  of  the  business  operations,  and  is  absolutely  no 
gauge  of  the  net  losses  or  gains  incurred  in  a  specific  period 
of  time.  Profi^ts  may  be  earned,  though  not  actually 
realized  in  cash.  Items  of  expense  are  frequently  incurred, 
though  not  yet  due  and  not  yet  paid.  These  principles 
are  so  commonplace  and  so  widely  accepted  by  all  ac- 
quainted with  business  affairs  that  an  apparent  attempt 
to  insert  in  a  tax  measure  an  obsolete  method  of  determin- 
ing income  justly  arouses  the  bitterest  opposition.       ^ 

But,  whatever  may  have  been  the  motives  or  intentions 
in  endeavoring  to  define  by  legal  enactment  a  method  of 
computing  net  income  in  direct  violation  of  prevailing 
practice,  certainly  the  interpretations  of  the  objectionable 
provisions  of  the  law  by  the  Secretary  of  the  Treasury 
demonstrate  that  effort  is  made  in  the  application  of  the 
tax  to  comply  with  actual  accounting  practice.  The  situa- 
tion is  interesting  in  view  of  the  conflicting  opinions  re- 
garding the  nature  of  the  tax  expressed  by  the  Attorney- 
General  and  by  the  executive  officials  of  the  Treasury 
Department.  The  Attorney-General,  in  his  reply  to  the 
accountants,  stated  that  the  proposed  tax  was  not  on 
'* profits"  but  on  *Uhe  entire  net  income  over  and  above 
five  thousand  dollars  received  by  the  corporation  subject 
to  the  law."  The  return,  therefore,  requires  statements 
of  actual  receipts  and  payments,  and  not  of  profits 
*^ gained,"  expenses  "incurred,"  interest  "accrued"  and 
losses  "ascertained."  The  Secretary  of  the  Treasury  evi- 
dently does  not  approve  of  this  view,  which  assesses  the 
tax  in  as  absurd  a  manner  as  when  a  poll  tax  is  levied 


THE  FEDERAL  CORPORATION  TAX    371 

according  to  the  length  of  the  individual's  nose  or  the  color 
of  his  eyes  and  the  texture  of  his  hair.  The  official  instruc- 
tions concerning  the  form  of  returns  and  the  manner  of 
assessing  the  tax  specifically  state  that  the  tax  is  levied 
on  net  profits.  The  expression ' ' net  income ' '  is  used  merely 
"because  there  can  be  no  question  as  to  it  embracing 
amounts  of  income  received  from  .  .  .  any  source,  while 
there  might  be  some  question  as  to  whether  or  not  such 
items  would  be  included  in  the  expressions  *  gross  profits' 
or* gross  earnings.'  " 

A  detailed  study  of  the  official  regulations  for  making 
up  the  tax  returns  gives  convincing  evidence  that  it  is 
the  intention  of  the  administrators  of  the  law  to  interpret 
the  provisions  as  far  as  possible  in  accordance  with  pre- 
vailing accounting  principles.  The  Secretary  of  the  Treas- 
ury, when  considering  the  vexed  Question  of  interpreting 
the  law,  is  reported  to  have  consulted  eminent  account- 
ing experts,  wh  j  suggested  or  approved  the  rules  and  regu- 
lations drafted  for  the  enforcement  of  the  measure.  The 
official  definitions  of  the  terms  ''gross  income,"  ''income," 
*' profits,"  etc.,  conform  very  closely  to  the  definitions  com- 
monly accepted  by  accountants  and  others  concerned  with 
business  affairs.  The  application  of  the  tax  is  thereby 
rendered  much  more  practicable  and  effective  than  would 
have  been  the  case  had  the  opinions  expressed  by  the 
Attorney-General  been  allowed  to  stand. 

The  official  "softening"  of  the  objectionable  provisions 
'of  the  law  is  accomplished  partly  through  a  classification 
of  corporations  subject  to  the  tax  according  to  the  nature 
•of  their  business.  From  each  class  a  separate  form  of 
return  is  required.    The  classification  is  as  follows : 

(1)  Banks  and  other  financial  institutions,  including 
insurance  companies. 

(2)  Transportation  companies. 
'(3)  Manufacturing  corporations. 

(4)  Mercantile  corporations. 

(5)  Miscellaneous  corporations. 


372  A.  M.  SAKOLSKI 

Under  tlie  law  no  special  provision  is  made  for  mining 
corporations,  and  tliej^  are  classed  as  manufacturing  com- 
panies. 

The  definition  of  net  income  as  required  by  law  to  be 
stated  in  the  tax  returns  is  adjusted  to  the  nature  of  the 
business  of  each  class.  The  rules  prescribed  are  palpable 
efforts  to  correct  the  absurd  accounting  methods  proposed 
in  the  laAV.  The  ''gross  income"  of  banks,  insurance  com- 
panies and  transportation  companies  is  officially  defined  as 
*'the  gross  revenue  derived  from  the  operation  and  man- 
agement of  the  business,  together  with  all  amounts  of  in- 
come .  .  .  derived  from  all  other  sources."  The  word 
''revenue"  is  undoubtedly  used  advisedly  in  preference  to 
"receipts."  The  Interstate  Commerce  Commission  desig- 
nates "revenue"  as  the  gross  earnings  (i.  e.,  receipts  from 
operation),  exclusive  of  "income"  from  investments  and 
outside  sources.  Miscellaneous  receipts  are  designated  in 
the  Interstate  Commerce  Commission  schedules  as  "other 
income"  and  are  not  included  under  the  operating  revenues. 
In  the  tax  returns,  however,  "gross  income"  has  a  wider 
application  than  is  ordinarily  implied  in  "gross  revenue," 
since  it  embraces  income  received  from  all  sources,  includ- 
ing the  ]3rofits  from  the  sale  of  capital  assets.  Assuming 
transactions  to  be  on  a  cash  basis,  the  "gross  income"  of 
transportation  companies,  according  to  the  tax  returns, 
conforms  very  closely  to  actual  cash  receipts.  In  the  case 
of  banks  and  other  concerns,  however,  where  cash  or  an 
equivalent  is  the  commodity  dealt  in,  a  decided  distinction 
between  gross  revenue  and  gross  receipts  is  intended  in 
the  prescribed  methods  of  making  up  the  tax  returns. 

In  the  case  of  manufacturing  and  mercantile  corpora- 
tions, the  official  interpretations  clearly  distinguish  "gross 
income ' '  from  ' '  actual  receipts. "  "  Gross  income ' '  of  man- 
ufacturing concerns  is  defined  as  "the  total  amount  ascer- 
tained through  an  accounting  (through  an  inventory  in 
the  case  of  mercantile  corporations)  that  shows  the  differ- 


THE  FEDERAL  CORPORATION  TAX    373 

ence  between  the  price  received  for  the  goods  as  sold  and 
the  cost  of  such  goods  as  manufactured."  The  cost  of  the 
goods  "shall  be  ascertained  by  an  addition  of  a  charge  to 
the  account  of  the  cost  of  the  goods  as  manufactured  during 
the  year,  the  sum  of  the  inventory  at  beginning  of  the  year 
and  a  credit  to  the  account  of  the  sum  of  the  inventory  at 
the  end  of  the  year."  To  the  resulting  balance,  the  items 
of  other  income  or  profit  not  already  subject  to  the  tax 
are  to  be  added. 

Though  this  method  of  accounting  conforms  to  the  pre- 
vailing practice,  corporations  making  the  return  will  expe- 
rience serious  difficulties  from  the  requirement  in  the  offi- 
cial regulations  that  in  the  gross  income  no  account  shall 
be  taken  of  "allowances  for  depreciation  of  property  nor 
for  losses  sustained  which  are  to  be  taken  account  of  in 
ascertaining  the  net  income  subject  to  the  tax  under  the 
proper  heading  in  the  authorized  deductions."  The  prob- 
lem of  correct  depreciation  accounting  is  extremely  impor- 
tant in  modem  business  operations,  and  an  endeavor  to 
apply  specific  methods,  as  we  shall  point  out  later,  is  bound 
to  meet  with  serious  opposition. 

In  reference  to  the  statutory  deductions  by  which  net 
income  is  determined  from  gross  income,  the  Treasury 
Department's  regulations  seem  to  controvert  in  every  de- 
tail the  language  of  the  Act.  The  law  as  finally  enacted 
specifically  provides  that  "net  income  shall  be  ascertained 
by  deducting  front  the  gross  amount  of  the  income  .  .  . 
received  within  the  year  .  .  .  (first)  all  the  ordinary 
and  necessary  expenses  actually  paid  within  the  year  out 
of  the  income  in  the  maintenance  and  operation  of  its  busi- 
ness and  properties;  (second)  all  losses  actually  sustained 
within  the  year  and  not  compensated  by  insurance  or  other- 
wise, including  a  reasonable  amount  for  depreciation  .  .'  . 
and  (third)  interest  actually  paid  within  the  year  on  its 
bonded  or  other  indebtedness  to  an  amount  of  such  bonded 
or  other  indebtedness  not  ^exceeding  the  paid-up  capital 


874  A.  M.  SAKOLSKI 

of  the  corporation."  Heedless  of  the  literal  meaning  of 
these  provisions,  which  if  carried  out  to  the  letter  would 
have  rendered  the  Act  impossible  of  application,  the  Sec- 
retary of  the  Treasury  interprets  them  in  accordance  with 
correct  accounting  principles.  He  admits  that  "to  hold 
that  the  phrase  'actually  paid  within  the  year'  requires 
evidence  of  actual  disbursement  in  cash  during  the  year, 
would  prohibit  anything  like  accurate  returns  being  made 
by  any  corporation  and  would  render  it  impossible  to  carry 
out  the  main  purpose  of  the  law."  The  authorized  deduc- 
tions, therefore,  are  made  to  include  all  expense  items 
''acknowledged  as  liabilities  by  the  corporation  making  the 
return  and  which  are  entered  as  such  on  the  books  from 
January  1st  to  December  31st."  In  other  words,  net  in- 
come is  to  be  "made  up  from  the  ledger  and  not  from  the 
cash  book." 

In  ascertaining  the  "ordinary  and  necessary"  expenses 
included  under  the  authorized  deductions,  the  manufactur- 
ing and  mercantile  corporations  carrying  supplies  of  mate- 
rials on  hand  are  instructed  to  include  in  such  expenses 
and  charges  only  the  cost  of  the  materials  and  supplies 
actually  disbursed  and  used  in  the  operations  covering  the 
year  in  which  the  returns  are  made.  This  is  demanded 
by  every  sound  system  of  accounting.  The  tax  return, 
however,  covers  the  calendar  year — a  provision  not  objec- 
tionable in  itself,  but  one  that  is  likely  to  cause  consider- 
able expense  and  inconvenience  to  corporations  with  fiscal 
years  not  coinciding  with  the  calendar  year.  A  correct 
statement  of  profits  necessarily  requires  the  taking  of  an 
inventory  or  its  equivalent.  This  generally  involves  con- 
siderable expense,  delay  and  inconvenience.  The  necessity 
of  a  special  inventory  because  of  the  tax  is  a  just  source 
of  complaint  on  the  part  of  the  corporations  whose  fiscal 
year  differs  from  the  calendar  year.  To  avoid  as  much 
friction  as  possible  in  collecting  the  tax  for  the  calendar 
j^ear  of  1909,  the  instructions  issued  by  the  Treasury  De- 


THE  FEDERAL  CORPORATION  TAX    375 

partment  provide  that  ^*  Where  an  inventory  or  its  equiva- 
lent was  not  taken  at  the  close  of  the  year  1908,  a  supple- 
mentary statement  showing  such  inventory  approximately 
must  be  submitted  with  the  return."  No  similar  substitu- 
tion of  an  inventory  in  succeeding  years  is  permitted  in 
the  returns. 

The  requirement  of  a  separate  statement  of  depreciation 
expenses  under  the  authorized  deductions  will  likewise 
cause  considerable  inconvenience  and  difficulty  to  many 
corporations,  necessitating  in  some  instances  complete 
alteration  in  the  methods  of  computing  depreciation,  obso- 
lescence and  general  deterioration  of  property.  The  meth- 
ods of  charging  such  losses  vary  with  different  concerns. 
In  some  industries  expenses  covering  depreciation  are 
intricately  woven  with  the  expenses  of  repairs  and  renew- 
als, resulting  in  the  absence  of  separate  depreciation  ac- 
counts. In  others,  again,  the  various  kinds  of  depreciation 
and  deterioration  are  charged  to  separate  accounts.  Some 
items  of  depreciation  are  properly  included  among  the  ordi- 
nary expenses  of  maintenance  and  operation,  whereas 
other  items  are  met  by  appropriations  for  new  construc- 
tion, betterments,  etc.,  or  are  met  by  income  from  special 
sources  not  credited  to  the  revenue  account.  No  better 
illustration  of  the  complex  system  of  charging  off  deprecia- 
tion or  extinguishment  of  assets  prevailing  in  a  modern 
corporation  is  afforded  than  that  of  the  United  States  Steel 
Corporation.  The  income  account  exhibited  in  the  pub- 
lished reports  of  this  gigantic  industrial  combination  shows 
four  general  items  of  expense  wholly  or  partly  of  the  na- 
ture of  depreciation  or  amortization  charges.    These  are 

(1)  Sinking  funds  on  bonds  of  subsidiary  companies. 

(2)  Depreciation  and  extinguishment  funds   (regular 
provisions  for  the  year).  '^ 

(3)  Extraordinary  replacement  funds  (regular  provi- 
sions for  the  ydarj. 

■   (4)  Special  replacement  and  improvement  funds. 


376  A.  M.  SAKOLSKI  > 

These  items,  though  partly  chargeable  to  capital  ac- 
count, on  the  ground  of  promoting  increased  efficiency  and 
earning  capacity,  are  considered  by  the  managers  to  be 
a  proper  charge  against  current  earnings.  Whether,  under 
strict  accounting  principles  they  would  in  all  cases  be 
allowed  to  stand  as  necessary  depreciation  expenses  under 
the  authorized  deductions  is  largely  a  matter  of  opinion. 
Depreciation  accounts,  reserv^es  and  sinking  fund  accounts 
are  not  necessarily  entries  of  actual  and  tangible  transac- 
tions. They  are  records  of  provisions  occasioned  by  current 
or  prospective  losses  in  value.  The  money  value  of  the 
provisions  therefore  must  at  all  times  be  estimated,  the 
exact  amount  not  being  capable  of  absolute  determination 
in  advance.  The  estimates,  however,  should  be  based  on 
expert  opinion  and  the  lessons  of  experience,  and  it  is  a 
matter  of  business  policy  with  accountants  to  leave  such 
matters  to  the  managers  and  directors.* 

The  diverse  methods  of  providing  for  depreciation  in 
undertakings  having  comparatively  simple  and  uniform 


*The   annual   report   of  the    International   Harvester   Company   contains    a 
lucid    explanation    of    the    character    of    the    depreciation    and    extinguishment 
charges  in  a  modern  corporation  of  large  size  and  extensive  activities: 
"Reserves  for  Plant  Depreciation  and  Extinguishment: 

''The  annual  appropriations  from  earnings  for  depreciation  and  extin- 
guishment reserves  constitute  the  necessary  provision  for  the  impairment  and 
consumption  cf  the  plant  assets  utilized  in  the  output  of  the  product  and 
should  prove  sufficient  to  reproduce  the  properties  as  their  replacement 
becomes  necessarj\  Depreciation  on  plant  property  is  based  on  rates  estab- 
lished by  recognized  authorities.  Amortization  of  ores  is  calculated  at  rates 
which  will  provide  sinking  funds  sufficient  to  retire  the  whole  of  the  Com- 
pany's capital  invested  in  mining  properties  before  the  extinguishment  of  the 
ore  bodies.  Timber  depreciation  is  figured  at  the  market  values  of  stumpage 
for  the  various  kinds  of  timber  cut.  This  stumpage  provision  will  equal  the 
original  cost  of  the  timber  properties  when  the  present  standing  timber  is 
exhausted,  after  allowing  a  fair  residual  value  for  the  lands  either  for  re- 
forestry  or  for  agricultural  purposes, 
"Special  Maintenance: 

"These  reserves  provide  for  relining  of  blast  furnaces,  maintenance  of 
docks  and  harbors,  and  similar  renewal  work  which  is  of  a  current  nature, 
but  which  occurs  at  irregular  intervals.  To  provide  for  the  renewal  when 
it  becomes  necessary  the  future  cost  of  the  work  is  apportioned  over  current 
operations.  A  reserve  is  also  being  created  to  provide  for  the  elevation  of 
certain  railroad  tracks  in  the  city  of  Chicago,  and  an  initial  installment  of 
$200,000.00  was  set  aside  for  this  purpose  in  1908." 


THE  FEDERAL  CORPORATION  TAX    377 

operations  such  as  the  railroad  companies  was  well  exhib- 
ited when  the  Interstate  Commerce  Commission  prescribed 
equipment  depreciation  accounts  for  railroads.  The  rail- 
road companies  most  active  in  protesting  against  the  keep- 
ing of  such  accounts  were  among  the  largest  and  best- 
equipped  in  the  land.  It  was  claimed  on  the  part  of  some 
of  these  companies  that  the  renewals  and  repairs  to  their 
equipment  were  made  at  a  rate  which  tended  to  maintain 
the  property  at  a  uniform  standard  of  efficiency  at  all  times. 
Accordingly,  there  was  no  necessity  for  depreciation  ac- 
counts on  their  books.  A  number  of  other  railroads,  includ- 
ing the  Pennsylvania,  the  Baltimore  &  Ohio  and  the  Nor- 
folk &  Western,  provided  for  the  depreciation  of  equip- 
ment largely  through  interest  and  sinking  fund  charges 
on  their  equipment  obligations.  Probably  in  no  two  im- 
portant railroad  systems  were  the  methods  of  treating 
depreciation  charges  identical. 

Although  the  purpose  of  a  depreciation  account  is  to 
show  the  amount  set  aside  from  current  income  for  losses 
in  the  value  of  assets  due  to  use  or  obsolescence,  the  meth- 
ods of  accounting  for  such  losses  vary  according  to  the 
nature  of  the  business  and  the  judgment  of  the  proprietors 
or  accountants.  Professor  Lawrence  Dicksee,  in  his 
standard  work  ''Advanced  Accounting,"  describes  in  de- 
tail six  different  methods  of  computing  depreciation,  each 
having  advantages  and  disadvantages.  Though  for  general 
accounting  purposes  all  methods  may  be  equally  sound, 
the  employment  of  one  method  rather  than  another  may 
result  in  considerable  disparitj^  in  the  net  income  of  differ- 
ent periods.  The  setting  aside  of  a  fixed  amount  each  year 
to  cover  depreciation  of  an  important  group  of  assets,  in- 
stead of  varying  the  amount  according  to  the  actual  esti- 
mated depreciation  or  the  actual  estimated  earning  capac- 
ity of  the  assets  in  question,  can  easily  result  in  a  differ- 
ence in  the  net  earnings  of  the  business  during  one  year 
large  enough  to  determine  whether  or  not  the  tax  shall  be 


378  A.  M.  SAKOLSKI 

assessed.  The  claim  may  be  properly  made  that  a  de- 
ficiency in  net  earnings  in  one  year  due  to  use  of  a  vary- 
ing annual  rate  of  depreciation  is  offset  by  correspondingly 
increased  earnings  during  other  years,  but  unless  it  can 
be  assumed  that  the  tax  will  be  fixed  and  permanent,  this 
argument  has  no  bearing  on  the  problem  under  considera- 
tion. 

With  mining  companies  the  question  of  a  ''reasonable" 
allowance  for  depreciation  is  extremely  complex  and  diffi- 
cult of  exact  determination.  The  actual  depreciation  of 
the  machinery  and  equipment  can  be  determined  within 
moderate  limits,  but  the  actual  diminution  of  value  in  re- 
sources due  to  production  may  baffle  the  wisest  expert. 
No  provision  is  made  in  the  law  for  the  progressive  depre- 
ciation or  amortization  of  mine  properties,  but  it  seems 
safe  to  conclude  that  the  corporations  can  include  an  esti- 
mate of  such  charge  in  the  expenses  of  the  year. 

The  statutory  requirement  of  a  separation  of  deprecia- 
tion charges  from  the  ordinary  and  necessary  expenses 
of  operation  and  maintenance  has  an  administrative  ad- 
vantage in  gauging  false  returns.  Unless,  however,  con- 
siderable freedom  is  permitted  in  estimating  depreciation 
and  similar  expenses,  serious  friction  and  inconvenience 
will  result. 

The  statutory  provision  concerning  losses  to  be  deducted 
from  gross  income  covers  losses  that  are  "actually  sus- 
tained." The  expression  "actually^  sustained"  has  been 
severely  criticised  by  accountants,  on  the  ground  that  the 
correct  amount  of  losses  chargeable  against  the  income  of 
a  year  is  frequently  not  ascertained  until  a  subsequent 
period.  The  distinction  between  losses  "sustained"  and 
losses  "ascertained"  is  of  considerable  importance  in  some 
industries.  In  transportation,  in  mining  and  in  construc- 
tion operations,  the  financial  losses  resulting  from  wrecks, 
accidents  and  other  disasters  are  frequently  not  determined 
until  after  a  series  of  adjustments  or  legal  adjudications 


THE  FEDERAL  CORPORATION  TAX    379 

extending  over  a  period  of  years.  It  is  the  practice  of  many 
concerns  to  carry  suspense  accounts  to  cover  liabilities  of 
an  uncertain  nature.  No  provision  permitting  this,  how- 
ever, is  found  either  in  the  law  itself  or  in  the  regulations 
pertaining  to  its  execution. 

The  use  in  the  law  of  the  expression  ''actually  paid" 
in  connection  with  interest  charges,  if  applied  literally  in 
the  execution  of  the  Act,  would  have  been  a  gross  viola- 
tion of  modem  accounting  practice.  Interest  obligations 
are  generally  payable  half-yearly,  but  the  date  of  disburse- 
ment varies,  not  only  with  different  corporations,  but  with 
different  issues  of  securities  of  the  same  corporation.  A 
corporation  with  interest  charges  payable  at  the  end  of 
January  instead  of  December  may  show  a  different 
^'actual"  disbursement  for  the  calendar  year  covered  in 
the  tax  returns  than  is  exhibited  by  the  books  of  account. 
The  omission  from  the  financial  statements  of  business 
concerns  of  liabilities  accrued  but  not  actually  due  or  dis- 
bursed, is  a  fruitful  source  of  fraud  and  deception.  Ac- 
countants and  auditors  guard  closely  against  this  means 
of  misrepresentation.  Hardly  two  years  ago  a  secretary 
of  a  public  service  corporation  issued  a  statement  of  net 
earnings  on  June  1  for  the  previous  five  months,  putting 
in  all  the  items  of  earnings  and  expense  for  the  time,  but 
ignoring  the  accrued  interest  on  $750,000  of  5  per  cent 
bonds  outstanding,  on  the  ground  that  the  coupons  were 
not  due  until  July  1  and  were  therefore  not  a  liability  at 
the  time  the  statement  was  made  up.  The  modern  method 
of  accounting,  based  on  the  system  of  accruals,  is  alto- 
gether contrary  to  this  idea.  It  is  the  evident  intention 
of  the  Treasury  Department  to  follow  accounting  prin- 
ciples in  spite  of  the  phraseology  of  the  law.  *^A11  ex- 
pense items  under  the  various  heads  acknowledged  as  lia- 
bilities by  the  corporations  making  the  return  are  held  to 
be  proper  deduction  from  gross  income." 

An  interesting  query  arises  as  to  whether  liabilities  ac- 


380  A.  M.  SAKOLSKI 

knowledged  by  a  corporation  on  account  of  unpaid  cumu- 
lative dividends  on  preferred  stock  are  a  proper  deduction 
from  gross  income.  Cumulative  dividends  as  a  legal  lia- 
bility may  differ  in  character  from  interest  charges,  but 
from  a  strict  accounting  point  of  view,  the  only  distinction 
is  that  the  pajTnent  of  the  dividends  can  be  postponed 
indefinitely  regardless  of  net  earnings,  whereas  the  interest 
charges  are  met  from  current  income.  In  both  cases,  the 
charge  is  for  the  use  of  capital  and  remains  a  liability  until 
paid.  The  general  balance  sheets  of  corporations  ordi- 
narily do  not  include  back  dividends  on  cumulative  pre- 
ferred shares  among  liabilities.  This,  however,  is  a  matter 
of  custom  rather  than  reason.  The  indebtedness  is  a  lien 
against  surplus  earnings  and  assets  and  is  therefore  a  lia- 
bility. In  view  of  the  accounting  practice,  there  can  be 
little  doubt  that  in  the  returns  made  by  corporations  under 
the  federal  corporation  tax  law,  no  deduction  from  gross 
income  on  account  of  cumulative  dividend  charges  will  be 
permitted  though  such  charges  may  be  "acknowledged  as 
liabilities"  and  are  "so  entered  on  the  books  as  to  consti- 
tute a  liability  against  the  assets  of  the  corporation  mak- 
ing the  return." 

Aside  from  the  relations  of  the  new  corporation  tax 
law  to  the  general  principles  of  accounting  practice  a  num- 
ber of  minor  though  not  altogether  unimportant  bookkeep- 
ing and  accounting  problems  are  involved  in  the  assess- 
ment of  the  tax.  These  will  undoubtedly  call  for  formal 
decisions  on  the  part  of  both  the  administrative  officials 
and  the  courts.  The  complexity  of  corporate  organization 
and  corporate  activities  has  rendered  practically  impos- 
sible the  intelligent  and  accurate  statement  of  the  financial 
results  of  business  corporations  in  the  form  of  a  brief 
schedule.  Considerable  latitude  of  variation  from  the  exact 
facts  in  any  particular  case  may  result  without  a  "wilful 
intent  to  defraud  the  Government  of  revenue."  Almost 
every  statement  of  profits  of  a  going  concern,  no  matter 


THE  FEDERAL  CORPORATION  TAX    381 

how  carefully  and  conscientiously  drawn  up  is,  at  best, 
an  estimate  and  not  a  statement  of  positive  truth.  Both 
English  and  American  courts  have  held  that  inasmuch  as 
the  ascertainment  of  profits  is  necessarily  a  matter  of  esti- 
mate or  opinion,  ''all  that  is  required  is  that  the  estimates 
be  fairly  and  honestly  made  without  any  fraudulent  inten- 
tion or  purpose  of  deceiving  anyone  and  that  they  conform 
to  the  constitution  of  the  corporation."*  It  can  hardly  be 
expected,  therefore,  that  in  the  determination  of  net  in- 
come for  the  purpose  of  tax  assessment,  such  processes  as 
an  inventory  of  the  material  on  hand,  the  cost  of  finished 
or  partly  finished  goods,  the  wear  and  tear  of  machinery 
and  other  equipment,  liability  to  losses  from  bad  debts, 
losses  from  obsolescence  and  extinguishment  of  assets,  etc., 
etc.,  will  be  accounted  for  similarly  in  all  corporations  and 
will  conform  in  every  detail  to  actual  fact.  The  earning 
of  profits  represents  a  continuous  operation.  Actual  re- 
sults can  be  definitely  stated  only  when  the  business  is 
wound  up  and  all  assets  realized  in  the  form  of  cash. 

The  great  diversity  in  the  methods  and  activities  of 
business  corporations  underlies  many  of  the  difficulties  to 
be  met  with  in  taxing  their  net  incomes  on  an  equitable 
basis  conforming  to  accounting  practice.  The  endeavor  to 
obviate  these  difficulties  by  a  simple  classification  of  busi- 
ness corporations  into  categories  can  be  only  partially  suc- 
cessful. The  methods  of  accounting  in  large  corporations 
are  frequently  impractical  when  applied  to  small  concerns 
of  the  same  class.  Capitalized  items  of  expense  in  one 
case  may  constitute  proper  charges  against  income  in  the 
other,  and  small  capitalization  may  effect  a  shovdng  of 
profits  which  would  be  entirely  wiped  out  under  a  large 
capitalization. 

,  Without  attempting  to  cover  in  detail  any  or  all  of  the 
accounting  problems  which  may  require  adjustment  in  the 
assessment  of  the  tax  upon  the  net  income  of  corporations, 

*  A.  Lowes  Dickinson;  "The  Profits  of  a  Corporation," 


382  A.  M.  SAKOLSKI 

a  few  will  be  selected  as  illustrations  of  the  difificulties  that 
may  be  expected  in  the  application  of  a  general  tax  on 
corporate  incomes. 

The  treatment  of  extraordinary  or  extraneous  income 
in  the  tax  returns  will  undoubtedly  be  a  source  of  contro- 
versy. Almost  every  corporation  receives  occasionally 
large  items  of  income  or  experiences  exceptional  losses 
which  are  not  the  result,  either  directly  or  indirectly,  of 
its  operations.  Such  profits  or  losses  may  arise  from  the 
sale  or  transfer  of  fixed  assets,  from  the  issue  or  redemp- 
tion of  capital  securities,  or  from  the  investment  of  special 
reserve  or  trust  funds.  The  federal  law  imposing  the  tax 
on  the  income  of  corporations  requires  all  such  extraneous 
revenues  to  be  added  to  the  income  of  the  year  during  which 
they  are  received  and  all  such  losses  to  be  deducted.  In 
the  sale  of  fixed  assets  the  regulations  provide  that 

"If  the  assets  were  acquired  subsequent  to  January  1st,  1909,  the  difference 
between  the  selling  price  and  the  buying  price  shall  constitute  an  item  of 
gross  income  to.  be  adde'd  to  or  subtracted  from  gross  income  according  to 
whether  the  selling  price  was  greater  or  less  than  the  buying  price.  If  the 
capital  assets  were  acquired  prior  to  January  1st,  1909,  the  amount  of 
increment  or  depreciation  representing  the  difference  between  the  selling  and 
buying  price  is  to  be  adjusted  so  as  to  fairly  determine  the  proportion  of 
the  loss  or  gain  arising  subsequent  to  January  1st,  1909,  and  which  proportion 
shall  be  deducted  from  or  added  to  the  gross  income  from  the  year  in  which 
the  sale  was  made." 

This,  as  well  as  the  further  provision  that  to  the  price 
realized  for  the  asset  there  should  be  added  any  amount 
previously  charged  to  income  which  remains  as  a  depre- 
ciation reserve  to  such  asset,  can  cause  no  objection  in 
theory.  In  practice,  however,  profits  and  losses  of  the  na- 
ture described  above  are  in  many  cases  exceedingly  difficult 
to  determine.  Frequently  they  do  not  appear  in  the  in- 
come account  at  all,  but  are  credited  or  charged  directly 
to  a  reserv^e  or  an  asset  account.  Where  the  losses  are 
large,  as  in  the  dismantling  of  a  whole  plant  or  the  abandon- 
ment of  equipment  rendered  useless  through  unforseen 
circumstances,  the  total  net  income  of  the  year  may  be 
wiped  out  and  a  serious  deficit  result.    In  such  case  it  is 


THE  FEDERAL  CORPORATION  TAX    383 

only  fair  for  tlie  corporation  to  provide  for  the  loss  grad- 
ually out  of  the  profits  of  several  years.  Large  profits 
arising  from  a  similar  source  may  likewise  be  equitably 
distributed  over  a  period  of  years  instead  of  being  added 
in  a  lump  sum  to  the  net  profits  of  a  single  year.  The 
accounting  of  extraordinary  gains  and  losses  in  this  man- 
ner, however,  although  in  harmony  with  business  practice, 
is  evidently  not  permitted  by  the  regulations  governing 
the  imposition  of  the  federal  corporation  tax. 

The  proper  distribution  of  the  gains  and  losses  arising 
from  the  premiums  received  and  the  discounts  paid  in  the 
issue  of  capital  securities  likewise  have  no  consideration 
in  the  provisions  relating  to  the  tax.  Discounts  and 
premiums  on  securities  issued  are  an  addition  to  or  a  de- 
duction from  the  interest  rate  charged  for  the  use  of  capital. 
The  amount  thereof,  accordingly,  should  not  be  charged 
or  credited  to  the  income  of  a  single  year.  The  common 
practice  is  to  distribute  the  amount  of  the  gain  or  loss 
over  a  period  of  years,  conforming  where  possible  to  the 
period  during  which  the  securities  are  to  remain  an  obliga- 
tion of  the  corporation.  It  is  very  doubtful,  however, 
whether  this  procedure  will  be  permitted  in  the  making  up 
of  the  tax  returns.*       r 

The  payments  on  account  of  sinking  funds  and  amortiza- 
tion will  also  have  an  important  bearing  on  the  account- 
ing procedure  to  be  observed  in  making  up  the  tax  returns. 
Where  sinking  funds  are  accumulated  for  the  purpose  of 
debt  extinguishment  without  reference  to  corresponding 
waste  or  reduction  in  the  value  of  assets  the  payments 
theoretically  are  not  a  proper  charge  against  current  in- 
come. However,  because  of  the  practice  of  inserting  pro- 
visions in  trust  deeds  requiring  the  sinking  fund  payments 

*  Court  decisions  have  held  that  premiums  received  from  the  issue  of 
capital  securities  constitute  a  part  of  the  capital  of  the  corporation  and  as 
such  are  not  divisible  as  profits  among  the  shareholders.  Premiums  re- 
ceived from  the  issue  of  stock  and  bonds  are  usually  added  to  the  surplus  of  a 
corporation,  thus  becoming  a  part  of  working  capital  in  fact  as  well  as  in 
theory. 


384  A.  M.  SAKOLSKI 

to  be  charged  to  current  profits  in  the  same  manner  as 
interest,  such  charges  in  many  cases  are  regarded  as  proper 
deductions  from  gross  income  before  net  income  is  finally 
determined.  In  order  to  have  the  tax  returns  conform  to 
correct  accounting  principles,  it  is  essential  that  the  sink- 
ing fund  provisions  be  construed  in  accordance  with  their 
intent.  If  the  pajnnents  represent  merely  a  depreciation 
provision,  they  may  be  construed  as  proper  deductions 
from  gross  income.  On  the  other  hand,  if  the  payments 
represent  obligatory  reduction  or  extinguishment  of  debt 
without  corresponding  reduction  on  the  value  of  assets, 
they  should  have  no  place  in  the  tax  returns.  The  regu- 
lations of  the  Treasury  Department  contain  no  instruc- 
tions relative  to  an  analysis  of  the  purpose  and  intent  of 
sinking  fund  payments.  It  may  be  assumed,  however,  that 
the  corporations  subject  to  the  tax  will  be  allowed  much 
freedom  in  the  matter.  '<- 

A  further  question  of  correct  accounting  involved  in  the 
determination  of  the  net  income  of  corporations  subject  to 
the  tax  concerns  losses  imputed  to  a  decline  in  the  market 
value  of  current  assets.  An  established  rule  of  accounting- 
requires  current  assets  such  as  raw  materials,  manufac- 
tured goods,  etc.,  to  be  valued  at  cost  or  market  value, 
*' whichever  is  the  lowest."  A  decline  in  market  value 
below  cost  is  chargeable  against  the  business.  Different 
methods  of  accounting  for  the  loss  are  employed,  the  pro- 
cedure varying  according  to  the  nature  of  the  assets  in 
question  and  the  character  of  the  business.  The  decline 
in  market  value  may  be  merely  a  fluctuation  and  not  a 
permanent  loss  in  value.  The  policy  of  many  corporations 
is  to  account  for  such  reductions  in  market  value  through 
the  creation  of  reserves  among  their  liabilities  equal  to 
the  difference  between  the  market  (inventory)  value  and 
the  cost  value,  w  Charging  the  profits  of  the  year  with  an 
uncertain  loss  is  thus  avoided.  In  making  up  their  returns 
for  the  assessment  of  the  tax,  corporations  may  claim  the 


THE  FEDERAL  CORPORATION  TAX    385 

privilege  in  some  years  of  deducting  from  the  gross  income 
the  full  amount  of  loss  represented  by  the  declines  in  the 
market  value  of  current  assets,  without  crediting  the  profits 
of  other  years  with  the  recovery  of  such  losses.  How  far 
such  practices  will  result  in  evasion  of  the  tax  may  never 
be  determined.  Concerns  having  on  hand  large  supplies 
of  commodities  such  as  iron  ore,  cotton,  grain,  etc.,  whicli 
are  subject  to  sharp  fluctuations  in  market  price,  will  have 
ample  opportunity  to  adjust  the  returns  to  suit  their 
purposes. 

A  problem  of  no  small  importance  in  relation  to  corpo- 
ration profits  at  the  present  time  and  one  that  may  be  ig- 
nored entirely  in  the  assessment  of  the  tax  is  the  treat- 
ment of  the  so-called  '* paper  profits."  Such  profits  are 
not  realized  in  the  form  of  cash  or  its  equivalent  and  are 
accordingly  not  brought  into  the  revenue  statement  of  the 
corporation.  These  profits  arise  usually  in  the  exchange 
of  assets  or  in  the  redemption  of  liabilities.  They  may, 
however,  be  the  result  of  the  revaluation  of  assets  or  the 
receipt  of  stock  dividends.  Although  the  crediting  of  such 
profits  directly  to  surplus  does  not  affect  the  income  ac- 
count of  the  year  during  which  the  profits  are  *' written" 
on  the  books,  the  actual  income  earned  in  future  j^ears 
may  be  affected  whenever  the  increased  value  of  the  assets 
represented  by  the  ''paper  profits"  are  realized  in  the  form 
of  cash  through  sale  of  the  assets.  In  such  an  event  the 
final  realization  of  the  "paper  profits"  would  escajDe  taxa- 
tion, since  no  profits  mil  be  shown  by  the  books  of  the 
corporation.  Thus,  a  corporation  exchanges  securities  of 
$1,000,000  cost  value  for  other  securities  having  no  definite 
market  value,  but  which  are  placed  on  the  books  by  the 
directors  at  $1,500,000.  The  resulting  "paper  profit"  of 
$500,000  is  credited  to  the  surplus  account  of  the  corpora- 
tion, but  inasmuch  as  nothing  is  received  in  the  form  of 
cash  assets,  the  profit  does  not  appear  in  the  income  state- 
ment of  the  year.    Accordingly  no  tax  can  be  assessed  for 

B— VIII— 25 


386  A.  M.  SAKOLSKI 

the  amount.  During  the  next  year,  however,  the  securities 
in  question  are  sold  at  their  book  value.  The  "paper 
profit"  which  was  credited  to  surplus  the  previous  year 
thus  becomes  an  actual  profit  and  is  available  for  distribu- 
tion among  the  shareholders.  The  amount  is  not  subject 
to  the  tax,  however,  for  the  books  show  no  additional  in- 
come during  the  year  from  the  sale  of  the  securities,  but 
merely  a  transfer  of  assets.  Evasions  of  this  character 
would  not  be  uncommon  in  these  days,  when  many  of  the 
large  corporations  are  holding  companies,  and  mergers 
through  exchange  of  securities  are  constantly  taking  place. 
Many  other  instances  may  be  cited  of  possible  conflicts 
with  modern  accounting  practice  in  the  application  of  the 
federal  corporation  tax.  It  can  hardly  be  expected  that 
a  revenue  measure  of  as  wide  an  application  as  the  one 
under  consideration  can  meet  all  the  conditions  arising 
from  the  complexity  of  modem  business  organization.  It 
seems  to  be  the  administration's  policy  to  interpret  the 
provisions  of  the  law  as  broadly  and  as  liberally  as  is  con- 
sistent with  faithful  execution,  and  corporations  subject 
to  the  tax  are  not  required  to  follow  specific  methods  of 
bookkeeping  in  order  to  comply  with  the  measure. 


SECTION  E. 

PRIMER  ON  COST  KEEPING.* 

1.  The  Primer  on  Cost  Keeping  is  based  on  the  assump- 
tion that  a  system  of  cost  keeping  should  prove  of  value 
to  practically  every  administrative  officer  required  by  his 
position  to  judge  of  the  relative  efficiency  of  different  men, 
appliances,  and  methods  in  the  economical  production  of 
finished  work. 

2.  The  degree  of  refinement  to  which  the  analysis  of 
costs  in  any  system  should  be  carried  must  be  determined 
by  experience.  Certain  general  principles  can,  however, 
be  laid  down.  If  the  system  does  not  go  sufficiently  into 
detail,  it  is  probable  that  discrepancies  in  the  cost  of  identi- 
cal products  at  different  locations,  under  different  condi- 
tions, handled  by  different  employes,  or  produced  by  dif- 
ferent methods,  will  not  be  indicated,  and  that  the  purpose 
of  cost  keeping  will  be  defeated.  If  the  system  is  too  com- 
plex, it  wiU  be  slow  and  heavy,  may  break  of  its  own  weight, 
and  its  results  may  be  reached  too  late  to  apply  corrective 
measures. 

3.  The  successful  system  must  be  along  lines  coming 
within  these  limits,  and  for  a  beginning  it  is  believed  that 
it  should  be  as  simple  as  will  secure  results,  with  a  view 
to  its  expansion  along  such  lines  as  experience  may  show 
to  be  desirable.  It  should,  however,  be  planned  to  have 
the  cost  accounts  square  in  or  be  in  agreement  with  the 
general  fiscal  records.  The  additional  expense  of  such  a 
detail  is  usually  more  than  compensated  for  by  the  check 
thus  afforded  upon  both  systems  and  the  additional  re- 


*  Originally  prepared  under  the  direction  of  a  special  committee  appointed 
by  President  Roosevelt  and  here  reproduced  by  permission  of  Hon.  Lawrence 
O.  Murray,  chairman. 

387 


388  PRIMER  ON  COST  KEEPING 

spect  wMcli  cost  data  from  such  systems  receive.  While 
exact  agreement  is  the  accounting  ideal,  approximate  agree- 
ment will  secure  valuable  results;  and  if  absolute  accuracy 
can  be  obtained  only  at  great  expense  such  approximation 
may  be  sufficient. 

4.  In  making  the  initial  outline  for  a  cost  system  it 
will  be  advisable  to  carry  the  analysis  further  along  the 
line  of  the  purposes  or  operations  for  which  expense  is 
incurred  than  along  the  line  of  the  nature  of  the  individual 
items  of  expense.  Thus,  in  a  scientific  bureau  it  is  of  more 
importance  to  know  the  costs  of  the  field  investigations, 
the  office  investigations,  the  laboratory  work,  the  comput- 
ing, the  editing,  and  the  administration  than  to  know  the 
costs  for  services,  travel,  purchases,  rentals,  etc. 

5.  It  is  absolutely  necessary  in  planning  such  a  system 
to  have  in  mind  the  scheme  of  organization  upon  which  it 
rests.  For  this  reason  no  uniform  system  is  possible  for 
organizations  of  different  kinds.  Such  systems  are  at  best 
only  suggestive  of  others.  If,  however,  it  is  desired  to 
study  some  such  systems  and  to  note  the  relation  of  various 
forms  devised  to  record  the  steps  in  the  processes,  the 
reader  is  advised  to  consult  the  two  books  by  Horace 
Lucian  Arnold,  The  Complete  Cost  Keeper,  and  The  Fac- 
tory Manager  and  Accountant.  Probably  neither  of  these 
systems  could  be  adapted  to  the  needs  of  any  governmental 
organization,  but  these  books  and  the  others  hereafter  re- 
ferred to  are  suggestive  and  valuable. 

6.  As  the  results  are  valuable,  primarily,  to  the  admin- 
istrative officer  in  direct  charge  of  the  operations  covered 
by  the  cost  accounts,  he  should  suggest  the  lines  along 
which  they  should  be  kept,  and  should  know  of  the  steps 
followed  in  its  processes,  and  thus  he  will  be  able  to  judge 
of  its  results.  He  need  not  prepare  the  forms  or  keep  the 
records — ^bookkeepers  and  clerks  will  be  available  to  per- 
form such  service — ^but  he  should  be  able  to  judge  of  the 


PRIMER  ON  COST  KEEPING  389 

quality  of  the  work  submitted  upon  the  outline  he  has  laid 
down. 

7.  Cost  keeping  is  that  branch  of  accounting  which  is 
concerned  with  the  segregation  of  the  various  items  of  ex- 
pense, incurred  in  the  prosecution  of  a  single  piece  of 
work,  from  among  all  other  items  of  expense  incurred  in 
a  general  line  of  industry,  and  the  setting  over  against 
the  total  of  such  segregated  items  the  quantity  of  result- 
ant work  or  product.  The  definition  of  cost  keeping  as  a 
part  of  a  general  system  of  accounting  can,  perhaps,  be 
made  clearer  by  the  following  contrast,  wherein  under 
''Scope  of  general  bookkeeping"  we  include  all  fiscal 
transactions  of  every  class,  and  under  ''Scope  of  cost 
keeping"  such  transactions  of  each  class  as  are  neces- 
sary for  a  complete  cost  system  for  so  much  of  the 
organization's  operations  as  the  system  is  intended  to 
cover.  Commercial  accounting  is  more  and  mo^'e  nearly 
approaching  the  ideal  as  to  costs,  but  it  is  not  yet  the  uni- 
versal rule  to  have  commercial  bookkeeping  show  a  com- 
plete analysis  of  the  purpose  of  all  transactions.  Govern- 
mental bookkeeping,  except  in  certain  classes  of  accounts, 
has  always  been  limited  to  a  record  of  cash  transactions, 
and  when  so  limited  excludes  from  its  record  all  transac- 
tions resulting  in  accounts  receivable  or  payable  and  all 
transactions  wherein  there  is  a  transfer  of  property  or  of 
services  without  any  corresponding  transfer  of  money, 
either  contemporaneously  or  subsequently. 

General  bookkeeping,  as  here  used,  includes  every 
transaction  which  involves  the  fiscal  condition  of  the  or- 
ganization. 

SCOPE  OF  GENERAL  BOOK-  SCOPE  OF  COST  KEEPING.       . 

KEEPING. 

8.  General     bookkeeping     is     con-  10.  Cost  keeping,  on  the  other  hand, 

cerned  with  all  considers  only  those 

A — resources;    valuable    assets    of  A — resources  which  are  employed 

whatever  nature  available  for  in    the    operations    for    which 

use  in  the  operations  of  any  costs  are  sought,  as  the  ma- 


390 


PRIMER  ON  COST  KEEPINa 


business,     whether 
actually  employed; 


or    not 


B — liabilities;  indebtedness,  with- 
out regard  to  how  or  when  in- 
curred; 


C — income;  cash  receipts,  wheth- 
er from  earnings,  borrowed 
funds,  or  other  sources; 


D — expenditures;    cash    disburse- 
ments,   whether    in    payment 
for    material    and    labor    fur- 
nished,   repayments    of   loans 
or  dividends; 
E — gains,  whether  resulting  from 
productive  operations,  or  from 
the  enhanced  value  of  assets 
either  fiscal  or  material; 
F — losses,  whether  resulting  from 
productive  operations  or  from 
other  causes,  as  trade  condi- 
tions,   material    disaster,    liti- 
gations, etc. 
9.  General    bookkeeping    as    a    rule 
considers    the    operations    of    an    or- 
ganization, both  fiscal  and  industrial, 
as  a  whole  or  in  large  sections.     Its 
entries  cover,  generally,  the  exchange 
of   value    between    individuals    or    in- 
dependent organizations.     It  does  not 
take    account    of    inventories    of    ma- 
terials, of  machinery,  tools  or  equip- 
ment,  of  plant,   or  of  other  valuable 
assets;  nor  consider  the  questions  of 
depreciation,  fixed  charges  and  liabili- 
ties   accrued   but   not    due,    except   at 
periods  of  profit  taking 


terials  and  supplies  consumed 
and  the  plant  employed,  but 
not  any  unproductive  capital 
which  may  be  held  for  future 
use; 

B — liabilities,  or  portions  thereof, 
which  are  incurred  wholly  for 
the  given  operations,  as  the 
indebtedness  for  materials  and 
labor  used,  but  not  borrowed 
capital,  nor  the  indebtedness 
for  unused  material  purchased 
against  possible  rise  in  price; 

C — incomes  which  are  drawbacks 
or  direct  repayments  upon  the 
elements  of  cost  entering  the 
given  product  as  refunds  of 
paid  overcharges  on  any  kind 
of  expense  entering  the  pro- 
duct, but  not  receipts  for  pro- 
duct previously  manufactured 
and  sold; 

D — expenditures  which  are  the 
measure  of  certain  expenses 
incurred  in  producing  the 
given  output,  but  not  pay- 
ment of  liabilities  generally; 

E — gains  which  are  drawbacks  as 
referred  to  under  income,  but 
not  profits  in   general; 

F — losses     which     are     industrial, 
such  as  depreciation  of  build- 
ings  and   equipment,   but   not 
those   which   are   commercial, 
such   as   bad   debts,   etc. 
11.  Cost   keeping   considers   the    in- 
dustrial operations  of  an  organization 
in  detail,  but  is  not  concerned  in  its 
purely  fiscal  transactions.     Its  entries 
cover  the  movement  of  values  within 
the  organization  itself  rather  than  be- 
tween it  and  others.     It  must  consider 
the  inventories  of  all  materials,  plant, 
etc.,   from   day   to    day,   and   take   ac- 
count   of    depreciation,    fixed    charges 
and   liabilities   accrued,   in   proportion 
to  the    charge    which    these  expenses 
become     upon     the     articles     of     the 
finished  product. 


12.  The  contrast  between  general  commercial  book- 
keeping and  cost  keeping  is  not  always  clearly  drawn.  In 
fact,  the  two  purposes  are  often  attempted  in  one  scheme 
of  accounting  where  the  product  is  practically  uniform 


PRIMER  ON  COST  KEEPINa  391 

and  the  operations  are  continuous.  In  sucli  cases  a  good 
system  of  analytical  bookkeeping  is  often  sufficient  when 
an  analysis  is  made  according  to  the  purpose  as  well  as 
the  nature  of  the  expense.  For  example,  the  accounts  of 
all  plants  for  the  production  and  distribution  of  power, 
heat,  light,  or  water  can  probably  be  best  handled  by  such 
a  method.  Unit  costs  may  be  obtained  by  making  a  sum- 
mation of  the  charges  to  certain  accounts  and  measuring 
the  amoun,t  of  the  product  or  output  for  the  period  cov- 
ered by  such  accounts. 

13.  In  the  commercial  world,  profit  is  the  test  and 
measure  of  success.  Profit  is  the  excess  of  value  received 
over  the  cost  of  producing  and  marketing.  Competition 
makes  price  fixing  a  matter  largely  beyond  the  control  of 
the  producer;  therefore,  the  possibility  for  increased 
profit  lies  only  in  a  reduction  of  the  cost  of  producing  and 
marketing.  Usually  this  cost  is  made  up  of  various  ele- 
ments of  expense,  and  it  is  necessary  to  get  at  the  propor- 
tions and  amounts  of  such  elements  in  order  to  learn 
where  it  is  possible  to  economize  without  injuring  the 
product. 

14.  We  thus  come  to  the  governing  principle  of  cost 
accounting,  which,  by  collating  such  information,  enables 
the  producer  to  know  the  amounts  of  the  several  elements 
of  expense  which  have  entered  into  the  total  cost  of  any 
piece  of  work,  and  from  such  information  to  develop  more 
economical  methods  for  the  conduct  of  future  operations. 

15.  From  the  standpoint  of  profit  there  does  not  seem 
to  be  the  necessity  for  the  study  of  costs  in  governmental 
work  that  there  is  in  the  commercial  world,  but  the  rela- 
tion between  the  outlay  of  money  and  the  return  of  valu- 
able product  is  much  the  same  in  the  government  service 
as  in  private  work.  Results  should  be  viewed  in  the  light 
of  their  costs.  In  many  instances  public  policy  may  re- 
quire the  Government  to  remain  in  enterprises  not  actual 
successes  from  the  commercial  point  of  view,  viz,  that  of 


S92  PRIMER  ON  COST  KEEPING 

producing  articles  as  cheaply  as  they  can  be  purchased. 
For  instance,  in  the  construction  of  fortifications  or  the 
manufacture  of  ordnance  the  Government  might  continue 
the  present  system  in  order  to  retain  control  of  important 
information  and  plans,  even  if  such  fortifications  could  be 
built  more  cheaply  by  contract  or  the  arms  obtained  more 
cheaply  by  purchase.  But  even  in  such  cases  the  study 
of  the  component  elements  of  expense  and  the  attending 
conditions  may  eventually  lead  to  such  modifications  of 
organization  and  methods  as  to  turn  a  hitherto  losing  or 
expensive  operation  into  an  actually  pajdng  enterprise. 
Actual  conditions  must  always  be  considered,  and  it  is 
undoubtedly  true  that  the  Government  cannot  do  all 
things  in  the  same  way  that  a  private  corporation  or  in- 
dividual can  do  them.  On  the  other  hand,  this  very  fact 
that  there  are  differences  in  attending  conditions  maj'  re- 
sult in  a  failure  to  pay  proper  attention  to  the  relation  of 
outlays  of  money  and  the  results  obtained  from  such  out- 
lays. 

16.  Governmental  cost  keeping  should  aid  in  obtain- 
ing economical  administration,  in  perfecting  effective  or- 
ganization, and  in  estimating  the  expense  for  future  op- 
erations along  similar  lines. 

17.  Comparatively  little  has  been  written  upon  cost 
keeping,  because  this  subject  is  a  very  recent  development 
in  accounting,  which  has  been  bom  of  the  necessity  of  pro- 
viding the  very  best  information  for  the  producers  of  this 
industrial  age.  A  bibliography  of  the  subject  appears  at 
the  end  of  this  primer.  It  is  interesting  to  note  that  the 
earliest  publication  on  the  general  subject  was  from  the 
pen  of  an  officer  of  the  Ordnance  Department  United 
States  Army,  and  had  particular  reference  to  the  systems 
in  use  in  the  arsenals  of  the  United  States. 

18.  The  first  important  step  in  cost  keeping  is  to  know 
the  results  for  which  the  organization  is  working.  Though 
as  a  matter  of  time  the  elements  of  expense  come  before 


PRIMER  ON  COST  KEEPING  393 

the  finished  product,  yet  it  is  necessary  that  the  adminis- 
trative officer  who  desires  satisfactory  cost  accounts 
should  in  advance  determine  upon  the  lines  which  the  cost 
keeping  should  follow.  To  do  this  he  should  consider  the 
various  articles  of  his  finished  product  and  thereafter  an- 
alyze each  into  its  several  elements  of  expense,  according 
to  certain  general  classes  hereafter  set  out. 

19.  Each  government  organization,  according  to  its 
nature,  exists  for  the  purpose  of  producing  a  definite  out- 
put. This  product  consists  of  certain  valuable  results — 
either  those  which  are  produced  and  are  measurable  in 
bulk  and  are  not  usually  divided  into  separate  physical 
units,  or  those  which  consist  of  many  individually  com- 
plete units.  It  is  important  to  observe  this  classification, 
for  it  has  a  direct  bearing  upon  the  form  of  the  account- 
ing system  which  will  best  procure  the  costs  of  produc- 
tion of  any  organization. 

20.  For  the  first  class,  whose  product  is  measurable  in 
bulk  and  not  usually  divided  into  separate  units,  a  system 
of  analytical  bookkeeping  is  sufficient,  when  such  an  anal- 
ysis of  the  expenses  has  been  made  according  to  the  pur- 
pose of  the  expenditure  that  the  costs  of  various  oper- 
ations are  obtainable  from  such  accounts.  Examples  of 
this  first  class  of  organizations  are  scientific  and  investi- 
gating bureaus  generally,  and  those  for  the  production  of 
power,  heat,  and  light,  for  conducting  transportation  en- 
terprises, and  for  each  individually  complete  section  or 
piece  of  work  of  the  Engineer  Department,  the  Isthmian 
Canal  Commission,  and  the  Reclamation  Service. 

21.  For  the  second  class,  the  units  of  whose  product 
are  individually  complete,  the  system  best  adapted  to  pro- 
cure satisfactory  results  is  that  known  as  factory  cost 
keeping  based  upon  individual  production  or  **job"  or- 
ders each  for  a  separate  item  of  output.  Examples  of  this 
second  class  of  organizations  are  the  manufacturing  ar- 


394  PRIMER  ON  COST  KEEPING 

senals,  the  naval  bureaus  of  ordnance,  equipment,  etc.,  the 
printing  offices,  etc. 

22.  In  addition  to  the  foregoing  general  classification 
of  all  business  enterprises  into  two  groups  according  to 
the  form  of  their  products  and  the  method  of  measuring 
them  it  is  desirable  also  to  classify  governmental  opera- 
tions according  to  their  nature.  By  so  doing  there  be- 
comes available  for  any  line  the  experience  gained  by  oth- 
er bodies  in  the  same  general  line,  both  governmental  and 
commercial.  Without  such  a  grouping  certain  underly- 
ing similarities  are  often  obscured  by  the  superficial  dif- 
ferences in  detail.    These  classes  are: 

23.  Manufacturing,  which  is  the  business  of  producing 
in  a  factory  a  large  number  of  identical  units  of  output  of 
one  or  more  kinds.    Factories  are  divided  into  two  classes : 

A,  Continuous  process  factories,  which  produce  ar- 
ticles in  bulk  and  in  which  the  individual  units  are  not  in 
practice  capable  of  identification  as  they  pass  through  one 
or  more  continuous  operations.  Examples:  Bureau  of 
Engraving  and  Printing,  in  manufacture  of  postage  stamps, 
and  mints  and  assay  offices  of  the  Treasury  Department; 
Bureau  of  Ordnance  of  the  Navy  Department,  in  the  manu- 
facture of  explosives;  and  any  power,  heating,  lighting, 
or  water  plants. 

B.  Varied  process  factories,  which  produce  single  units, 
each  complete  in  itself,  or  groups  of  a  definite  number  of 
units  of  output,  and  where  it  is  practicable  under  ordinary 
conditions  to  measure  the  duration  of  each  step  in  the  pro- 
duction of  such  individual  units  or  groups.  The  product 
of  such  varied  process  factories  will  usually  contain  ele- 
ments which  are  the  results  of  continuous  processes  simi- 
lar to  those  of  the  former  class  of  factories.  Examples: 
Bureau  of  Engraving  and  Printing  of  the  Treasury  De- 
partment, in  its  miscellaneous  printing;  Ordnance  Depart- 
ment of  the  War  Department;  Di^dsion  of  Mail  Equip- 
ment of  the  Post-Office  Department;  Bureaus  of  Equip- 


PRIMER  ON  COST  KEEPING  395 

ment,  Ordnance,  and  Steam  Engineering  of  the  Navy  De- 
partment; Bureau  of  Standards  of  the  Department  of  Com- 
merce and  Labor;  Government  Printing  Office. 

24.  Construction,  which  is  the  business  of  producing 
outside  of  a  factory  a  relatively  large  work,  which,  while 
composed  of  lesser  units,  makes  only  one  complete  prod- 
uct.   It  is  of  two  general  classes: 

A.  Continuous  process  construction,  in  which  the  out- 
put, consisting  of  excavation,  grading,  or  masonry,  is 
gradually  and  continuously  produced  without  separation 
into  individual  units,  and  in  which  the  work  includes  one 
or  more  continuous  operations  carried  on  under  uniform 
conditions.  Examples:  Engineer  Department  and  Signal 
Office  of  the  War  Department;  Reclamation  Service  of  the 
Interior  Department;  Isthmian  Canal  Commission. 

B.  Varied  process  construction,  in  which  severally 
completed  parts  are  assembled  and  brought  into  a  struc- 
ture under  varying  conditions  and  methods.  Examples: 
Supervising  Architect's  Office  of  the  Treasury  Department; 
Quartermaster-General's  Department  of  the  War  Depart- 
ment; Bureaus  of  Yards  and  Docks  and  Construction  and 
Repair  of  the  Navy  Department. 

25.  Transportation,  which  is  the  business  of  carrying 
persons,  property,  or  intelligence  from  point  to  point. 
Examples:  Transport  Service  of  the  Army  and  Navy,  Pan- 
ama Railroad,  the  Postal  Service,  and  the  cable,  telegraph, 
and  telephone  lines  of  the  Signal  Service.  As  a  line  of 
business  it  is  confined  to  the  profitable  use  of  a  plant  pre- 
viously secured  and  its  expenses  are  principally  for  opera- 
tion, maintenance,  administration,  depreciation  of  equip- 
ment, interest  on  investment,  etc.  The  principles  and  gen- 
eral method  of  its  accounting  will  apply  also  to  those  other 
enterprises  which  conduct  the  operation  and  movement  of 
ships,  etc.,  even  though  the  purpose  of  such  organization 
is  not  that  of  conducting  transportation,  as  in  the  cases 


396  PRIMER  ON  COST  KEEPING 

of  war  vessels  and  auxiliaries,  revenue  cutters,  light-house 
tenders,  coast  vessels,  quartermaster's  transports,  etc. 

26.  Merchapdising,  which  is  the  business  of  buying 
and  selling,  and  which  in  government  work  includes  the 
receipt  after  purchase  or  production  and  the  issue  by  sale 
or  requisition  of  valuable  property  from  any  of  the  many 
"stores"  of  the  government  service.  The  most  notable 
examples  are  the  stores  of  the  Bureau  of  Supplies  and 
Accounts  of  the  Navy  Department  and  the  Commissary 
Department  of  the  War  Department,  although  every  de- 
partment and  bureau  and  many  divisions  also  have 
** stores"  operating  as  above. 

27.  Investigation  and  Eeports,  which  includes  the  col- 
lection of  information,  either  in  the  field  or  office,  and 
either  from  original  study  of  existing  conditions  or  by  the 
collating  of  previously  gathered  information  on  file  in  va- 
rious places.  Examples:  Bureau  of  Trade  Relations  of  the 
State  Department;  Office  of  Commissioner  of  Education 
and  Geological  Survey  of  the  Interior  Department;  Bu- 
reaus of  Animal  Industry,  Chemistry,  Foreign  Markets, 
Plant  Industry,  Soils,  Entomology,  and  Biological  Survey, 
Office  of  Experiment  Stations  and  Public  Roads,  and  For- 
est Service  of  the  Department  of  Agriculture;  Bureaus  of 
Corporations,  Labor,  Census,  Statistics,  Fisheries,  and 
Standards  and  Coast  and  Geodetic  Survey  of  the  Depart- 
ment of  Commerce  and  Labor. 

28.  Accounting  and  Records,  which  as  a  business  would 
not  stand  alone,  but  is  a  necessary  detail  for  the  carrying 
on  of  actual  productive  enterprises,  and  which  under  gov- 
ernmental organization  is  often  handled  by  practically 
independent  bodies.  Examples:  Bureaus  of  Indexes  and 
Archives,  Accoimts,  Rolls,  and  Library,  of  the  State  De- 
partment; Offices  of  the  Comptroller  of  the  Treasury  and 
the  several  Auditors,  Treasurer,  and  Register  of  the  Treas- 
ury Department. 

29.  Administration  and  Supervision,  which  would  not 


PRIMER  ON  COST  KEEPINa  397 

stand  alone  as  an  independent  commercial  operation,  but 
is  a  necessary  factor  in  the  satisfactory  conduct  of  produc- 
tive enterprises,  and  which  as  the  primary  object  of  the 
executive  branch  of  the  Government  makes  many  organiza- 
tions practically  separate  from  those  which  are  directly 
productive.  Examples:  Diplomatic,  Consular,  and  Pass- 
port Bureaus,  of  the  State  Department;  Offices  of  Comp- 
troller of  Currency,  Internal  Revenue,  Customs,  Marine- 
Hospital  and  Life-Saving  Services,  of  the  Treasury  De- 
partment; the  military  arm  of  the  Aiiny  and  Navy;  Depart- 
ment of  Justice;  Offices  of  the  Commissioners  of  Patents, 
Pensions,  General  Land,  Indian  Affairs,  and  Railroads,  of 
the  Interior  Department;  Steamboat  Inspection  Service, 
and  the  Bureaus  of  Navigation  and  Immigration,  of  the 
Department  of  Commerce  and  Labor;  and  the  Interstate 
Commerce  and  Civil  Service  Commissions. 

30.  It  appears  that  the  work  of  every  government 
organization  can  be  set  down  as  that  of  one  or  more  of  the 
foregoing  seven  classes.  Many  which  have  one  line  as 
their  principal  work  may  have  incidental  operations  of  one 
or  more  of  the  other  classes.  The  last  two,  viz,  Account- 
ing and  Records,  and  Administration  and  Supervision,  are 
general,  and  every  organization  has  both  as  all  or  some 
portion  of  its  work,  but  these  as  classes  are  intended  to 
cover  only  those  organizations  which  are  not,  or  but  slight- 
ly, engaged  in  any  one  or  more  of  the  first  five  directly 
productive  classes. 

31.  Costs  of  production  of  identical  articles  produced 
at  different  times  have  a  value  to  the  producer  for  purposes 
of  comparison.  Costs  of  different  articles  produced  at  one 
time  are  valuable  for  purposes  of  comparison  in  so  far  as 
the  articles  pass  through  some  of  the  same  processes.  In 
general,  it  may  be  said  that  costs  aid  the  producer  (a)  in 
fixing  selling  prices  on  finished  product;  (b)  in  fixing  buy- 
ing prices  on  material  and  labor  entering  into  this  product; 

(c)  and,  most  important  of  all,  in  so  adjusting  operations 


398  PRIMER  ON  COST  KEEPING 

between  the  time  of  buying  the  material  and  labor  and 
that  of  selling  the  finished  product  that  there  shall  be  the 
minimum  of  expense  for  such  operations. 

32.  Cost  has  been  defined  as  "loss  of  any  kind,"  or 
** whatever  is  requisite  to  secure  benefit."  It  must,  there- 
fore, be  distinguished  from  disbursement,  for  it  will  also 
include  any  liability  if  the  benefit  therefrom  has  been  used, 
even  though  the  disbursement  therefor  has  not  been  made. 
Conversely,  disbursements  made  for  benefits  not  used  in 
producing  the  output  of  work  are  not  yet  a  part  of  costs. 

33.  When  cost  keeping  is  adopted  solely  for  reasons 
of  economy  and  organization  it  may  be  sufficient  to  stop 
uniformly  with  any  given  proportion  of  the  whole  cost, 
as  with  the  expenditures  from  specific  current  appropria- 
tions. Such  results  are  comparable.  When,  however,  it 
is  desired  to  have  costs  for  purposes  of  competition  or  com- 
parison with  the  market  prices  on  like  output,  or  with  the 
costs  obtained  in  other  government  organizations,  or  when 
it  is  necessary  to  fix  prices  for  sale  of  the  product  to  out- 
side parties,  or  to  other  government  organizations,  a  total 
cost  must  be  obtained,  showing  all  expense  of  every  kind, 
whether  paid  from  past  or  current  appropriations. 

34.  The  relation  of  the  disbursements  and  liabilities 
and  other  sources  of  benefit  to  the  total  available  resources 
on  the  one  hand,  and  of  these  same  resources  to  the  unused 
stores  and  other  valuable  assets  and  the  costs  of  output 
on  the  other,  can  perhaps  best  be  shown  by  the  diagram  on 
the  following  page. 

From  the  diagram  it  can  be  seen  that  the  total  of  the 
resources  available,  obtained  by  a  summation  of  the  items 
Nos.  1  to  6,  less  the  total  of  items  Nos.  7  to  9  (the  inven- 
tories available  for  future  use)  and  of  item  No.  10  (trans- 
fers gratis),  leaves  as  a  remainder  item  No.  11,  which  is 
the  cost  of  the  finished  product. 

Items  Nos.  1  and  7  refer  to  the  fixed  plant,  and  the 
difference  between  their  values  represents  the  wear  and 


PRIMER  ON  COST  KEEPING 


399 


SOURCES  OF  REVENUE. 
(Items  charged  to  organization.). 

1.  Use  of  buildings 
and  equipment  (plant) 
obtained  from  former 
appropriations. 

2.  Unused  stores  on 
hand  secured  from 
former    appropriations. 


3.  Unfinished  product 
or  results  of  work  done 
from  former  appropria- 
tions. 


4.  Disbu  rsements 
from  and  liabilities 
against  current  or  fut- 
ure appropriations  for 
the  organization. 

5.  Disbur  s  e  m  e  n  t  s 
from  and  liabilities 
against  current  or  fut- 
ure appropriations  for 
other  organizations. 

6.  Property  trans- 
ferred and  labor  de- 
tailed from  others 
"gratis." 


VALUABLE  OUTPUT. 
(Items  credited  to  organization.) 


7.  Buildings  and 
equipment  (plant)  pur- 
chased from  former 
and  current  appropria- 
tions and  available  for 
future  operations. 


8.   Unused   stores   on 
hand. 


Total  resources  avail- 
able for  and  aiding  in 
the  productive  work  of 
the  organization. 


9.  Unfinished  product 
or  results  of  work  on 
hand  for  future  opera- 
tions. 


10.  Property  trans- 
ferred and  labor  de- 
tailed toothers  "gratis." 


11.  Finished  product. 


tear  or  depreciation  of  such  plant,  except  in  so  far  as  it 
has  been  augmented  or  decreased  during  the  period  under 
review  by  transactions  covered  by  items  Nos.  4,  5,  6,  or  10. 
35.  The  expenditures  for  any  enterprise  while  operated 
appear  to  be  for  a  great  variety  of  obligations,  but  with 
all  their  differences  in  details  such  obligations  will  all  fall 
into  one  or  the  other  of  two  classes,  according  to  their 
character.  The  first  class  is  that  of  stores  or  property, 
bought  and  owned,  including  not  only  substances  of  a  tan- 
gible nature,  visible  to  the  eye,  and  capable  of  being  han- 
dled, but  also  less  evident  articles  of  commerce,  such  as 
gas  and  power,  purchased  by  measure.  The  second  class 
is  that  of  services,  which  includes  the  benefits  derived  from 
everything  hired  or  leased,  w^hether  in  the  form  of  labor 


400  PRIMER  ON  COST  KEEPING 

of  men  and  animals  hired  as  individuals,  or  in  tlie  form 
of  those  services  which  are  supplied  in  bulk,  as  rentals, 
transportation,  taxes,  insurance,  advertising,  interest,  con- 
tract or  job  work. 

36.  *' Stores,"  or  property,  as  indicated  in  the  last  para- 
graph, includes  all  property  bought  and  owned.  Such  prop- 
erty appears  to  be  capable  of  almost  unlimited  subdivision 
into  the  several  elemental  materials  and  the  combinations 
thereof  kno^\Ti  to  commerce;  but  if  viewed  from  the  stand- 
point of  the  use  to  which  they  are  put,  all  stores  or  prop- 
erty are  readily  divided  into  three  classes,  as  follows: 

A.  Materials. — Any  property  that  enters  into  and  re- 
mains a  part  of  the  finished  product  is  a  material.  Mate- 
rials are  often  referred  to  as  raw  material,  but  it  should  be 
noted  that  the  finished  product  of  one  operation,  some- 
times called  stock,  often  becomes  the  raw  material  of  a 
subsequent  operation,  and  is  then  designated  in  the  latter 
organization  as  stores. 

B.  Supplies. — All  property  that  is  used  upon  and  wholly 
consumed  in  the  operations  by  which  the  finished  product 
is  made. 

C.  Plant. — All  property  employed  in  the  operations  by 
w^hich  the  finished  product  is  made,  but  which  does  not 
enter  that  product  and  is  not  consumed  in  such  operations, 
excepting  as  to  wear  and  tear.  Plant  includes  real  estate 
and  improvements  thereon,  machinery  (both  fixed  and  mov- 
able), tools,  instruments,  vehicles,  animals  owned,  etc. 

37.  The  distinction  between  materials,  supplies,  and 
plant  is  not  always  an  easy  one  to  make  in  advance  of  their 
use,  though  when  the  articles  are  actually  employed  in 
productive  operations  there  should  be  no  difficulty  in  de- 
ciding into  which  class  any  article  should  go.  In  some 
instances  the  same  substance  is  differently  classified,  ac- 
cording to  the  disposition  that  will  be  made  of  it.  Timber 
may  be  sawed  into  lumber  and  become  material  for  the 
manufacture  of  furniture  or  it  may  be  transforaied  into 


PItlMEIR  ON  COST  KEEPINa  401 

plant  by  the  enlargement  of  the  factory  or  it  may  be  cut 
into  cord  wood  and  become  supplies  for  use  as  fuel. 

38.  But  whether  it  is  easy  or  difficult  in  any  case  to 
draw  the  distinction  between  the  three  classes  for  stores, 
the  reason  for  such  distinction  is  sound.  It  is  possible  to 
measure  the  quantity  of  materials  used  in  each  article  of 
the  product,  and  there  need  be  no  estimate  whatever.  It 
is  possible  to  measure  the  quantity  of  supplies  used  upon 
the  product  for  a  certain  period,  but  an  estimate  is  neces- 
sary in  distributing  such  expense.  It  is  impossible  to 
measure  accurately  depreciation  or  wear  and  tear  of  plant, 
and  both  the  amount  of  such  expense  and  its  distribution 
must  rest  on  estimates.  It  is  plain  that  most  accurate  re- 
sults are  obtained  by  so  classifying  expenses  as  to  group 
those  in  which  the  elements  of  uncertainty  and  estimate 
are  absent  either  at  the  minimum  or  at  the  maximum. 

39.  A  loose  use  of  the  word  ''cost"  in  connection  with 
stores  makes  it  practically  synonymous  with  purchase 
price.  Such  a  use  cannot,  however,  be  permitted  in  con- 
nection with  any  system  designed  to  obtain  the  costs  of 
production.  For  this  purpose  the  cost  of  stores  must  in- 
clude every  expense  incurred  upon  the  articles  when  de- 
livered for  the  initial  productive  operation.  Such  cost  will 
include  the  purchase  price;  buying  expense,  including  the 
preparation  and  printing  of  specifications,  advertising,  sal- 
aries, commissions,  and  expenses  of  purchasing  agents  and 
assistants;  transportation;  inspection  and  testing;  labor 
and  cartage  in  and  out  of  storehouses  and  the  clerical  labor 
connected  with  store  records  and  the  routine  of  issuing 
stores;  rental  of  store  buildings  when  leased  or  interest 
on  investment  in  such  buildings  and  depreciation  there- 
upon when  owned  by  the  United  States;  but  it  is  not  be- 
lieved that  the  element  of  expense  involved  in  a  possible 
interest  charge  on  the  money  invested  in  unused  stores 
carried  for  future  use  is  of  sufficient  importance  to  warrant 
its  inclusion  in  governmental  cost  keeping. 

B— VIII— 26 


402  PRIMER  ON  COST  KEEPING 

40.  In  other  words,  tlie  prices  to  be  charged  on  issued 
stores  should  be  sufficient  to  cover  every  expenditure  or 
liability  incurred  on  account  of  such  stores.  When  the 
storerooms  are  small  and  those  in  charge  have  other  duties 
of  a  dissimilar  character,  it  may  be  impracticable  to  in- 
clude some  of  these  different  items  and  necessary  to  carry 
them  into  some  general  administrative  account  to  be  pro- 
rated therewith,  but  this  method  should  be  avoided  when- 
ever practicable. 

41.  *' Services,"  as  already  pointed  out,  includes  all 
those  elements  of  value  or  benefit  which  are  not  bought 
and  owned,  but  which  are  hired  or  leased.  Services  may 
conveniently  be  divided  into  two  general  classes,  depend- 
ing upon  the  manner  in  which  they  are  secured,  viz,  indi- 
vidually or  in  bulk.  The  former  includes  all  man  and  ani- 
mal labor  secured  by  the  hire  of  individuals;  the  latter 
includes  all  services  where  the  work  is  performed  in  whole 
or  in  part  by  others  than  the  one  agreeing  to  supply  the 
labor.  Examples  of  this  class  of  services  are  job  or  con- 
tract work,  transportation  of  persons,  property,  or  intelli- 
gence, rental  of  buildings  or  equipment,  advertising,  insur- 
ance, taxes,  interest,  etc. 

42.  The  distinction  between  these  classes  is  not  of  the 
same  importance  in  cost  keeping  as  is  that  between  the 
classes  of  stores,  but  it  has  a  bearing  upon  the  subject, 
because  a  large  part  of  individual  labor  is  directly  produc- 
tive and  its  benefits  enter  directly  into  and  persist  in  the 
finished  product  somewhat  like  materials,  while  most  of  the 
bulk  service,  excepting  contract  work  and  transportation, 
is  non-productive  (indirectly  productive)  and  its  results  are 
so  consmned  in  the  processes  of  producing  the  output  as, 
like  supplies,  to  be  incapable  of  identification. 

43.  The  cost  of  personal  services,  or  compensation  of 
employes,  in  the  government  service  consists  primarily  of 
the  pay  proper,  or  salaries  and  wages,  and  this  element 
is  in  all  cases  the  principal  and  in  many  cases  the  only 


PRIMER  ON  COST  KEEPING  403 

cost  of  labor.  In  addition,  compensation  may  consist  ot 
allowances  for  traveling  expenses,  mileage,  quarters,  sub- 
sistence, per  diem  allowance  in  lieu  of  subsistence,  medical 
attendance,  clothing,  etc.  There  is  a  third  element  enter- 
ing into  the  costs  of  labor  in  the  government  service,  in 
that  of  lost  time,  which  consists  of  time  for  which  pay- 
ment is  made,  but  in  which  no  work  is  done.  The  total 
varies  in  different  branches  of  the  government  service. 
It  may  include  Sundays,  Saturday  half  holidaj^s,  regular 
holidays,  annual  leave  of  absence  (which  may  in  one  in- 
stance at  least  be  paid  for  when  earned  and  not  taken), 
and  sick  leave. 

44.  The  cost  of  animal  labor  will  include  the  agreed 
rate  at  which  hired,  the  cost  of  forage,  of  stabling  and 
care,  including  that  of  hostler,  farrier,  and  veterinarian. 

45.  The  cost  of  services  secured  in  bulk  is  not  often 
complicated  with  so  many  factors  as  is  that  of  individual 
service.  As  a  rule,  such  cost  consists  of  a  definite  number 
of  units  of  service  at  a  fixed  rate  per  unit.  If  an  agree- 
ment also  provides  for  a  hold-back  of  a  given  percentage 
until  the  completion  of  all  or  a  certain  portion  of  the  work 
the  deferred  liability  because  of  such  hold-back  must  be 
included  to  obtain  a  whole  cost. 

46.  "Whole  cost  or  total  cost  has  been  differently  con- 
sidered, some  persons  embracing  in  it  the  entire  expense, 
including  that  of  marketing  the  product,  while  others  have 
put  into  it  only  that  expense  necessary  to  bring  it  to  the 
point  where  it  is  ready  for  sale  or  delivery.  In  the  gov- 
ernment service  it  seems  better  that  all  expense,  includ- 
ing delivery,  should  be  reckoned  in  as  a  part  of  the  whole 
cost,  inasmuch  as  the  expense  of  marketing  and  delivery 
is  a  relatively  normal  and  even  one  over  all  the  articles 
of  any  one  line  of  product. 

47.  This  whole  cost  is  uniformly  divided  into  two  parts, 
each  of  which  has  been  known  by  various  terms,  as  follows: 

A.   Direct  charges,  otherwise  known  as  prime  cost  or 


404  PRIMER  ON  COST  KEEPING 

flat  cost,  which  consist  of  the  expense  for  a  given  product, 
of  the  material  used  in  and  remaining  a  part  of  that  prod- 
uct, and  the  productive  labor  directly  applied  to  it. 

B.  Indirect  charges,  otherwise  known  as  top  costs,  or 
on  cost,  or  general  expenses,  which  uniformly  include  all 
administrative  expense,  marketing  expense,  and  miscel- 
laneous charges  not  directly  assignable  to  any  specilic 
article  of  the  product. 

48.  The  factory  burden  is  one  element  of  cost  which 
has  been  variously  included  under  the  direct  or  indirect 
charges.  It  includes  depreciation,  cost  of  power,  heat  and 
light,  cartage,  elevator  service,  watch,  etc.  Another  ele- 
ment of  cost  is  that  for  interest,  taxes,  insurance,  or  rentals. 
Theoretically,  and  practically  from  the  commercial  point 
of  view,  such  expenses  are  means  for  the  distribution  of 
jDrofits.  In  the  government  service  there  is  no  distribution 
of  profits  in  the  common  forms  of  stock  dividends  or  inter- 
est on  bonds,  and  there  is  not,  therefore,  the  necessity  for 
treating  interest  as  distributed  profits,  which  should  be 
done  connnercially.  It  and  the  other  expenses  enumerated 
above  should  be  charged  to  separate  accounts  and  finally 
distributed  with  the  elements  of  the  factory  burden.  As 
a  general  rule,  it  is  better  to  limit  the  direct  charges,  or 
prime  cost,  to  those  elements  of  cost  in  which  there  is  no 
uncertainty  whatever,  and  into  which  there  does  not  enter 
the  personal  equation  of  any  sort  of  estimate.  However, 
it  is  probable  that  satisfactory  results  can  be  obtained  by 
making  a  direct  charge  for  power  and  similar  expenses 
in  those  lines  where,  because  of  the  fact  that  there  is  not 
a  great  variety  in  the  product  which  is  produced  under 
uniform  and  continuous  operations,  it  is  possible  to  assign 
these  charges  directly  to  the  finished  product. 

49.  In  connection  with  this  subject  of  the  division  of 
the  elements  of  cost  into  the  two  classes  of  direct  charges 
and  indirect  charges  it  must  be  noticed  that  these  terms 
recur  with  every  gradation  of  an  organization  through  the 


PRIMER  ON  COST  KEEPING  405 

subordinate  up  to  the  superior  body.  In  other  words,  the 
whole  cost  of  any  product  of  a  division  becomes  a  part  of 
the  direct  charges  or  prime  cost  of  the  bureau  in  which 
the  division's  product  of  work  is  carried  further  or  is  com- 
bined wijth  the  work  of  other  divisions  into  a  completed 
product  ready  for  the  market. 

50.  Apportionment  of  indirect  charges. — Various  meth- 
ods of  apportioning  the  top  cost  are  in  use  commercially. 
The  following  suggestions  are  necessarily  general  in  char- 
acter, but  should  serve  to  assist  in  determining  the  proper 
plan  to  be  adopted: 

A.  Prorate  the  top  cost  to  each  operation  upon  basis  of 
the  direct  labor  therein  to  the  total  direct  labor  affected 
by  such  top  cost  when  the  top  cost  consists  principally  of 
expense  of  supervision. 

B.  Prorate  the  top  cost  to  each  operation  upon  basis 
of  the  direct  labor  and  materials  therein  to  the  total  direct 
labor  and  material  when  the  top  cost  consists  of  expense 
of  supervision  and  of  procuring,  storing,  and  issuing 
material. 

C.  Prorate  the  top  cost  to  each  operation  upon  any 
other  basis,  as  machine  hours  employed  in  the  given  opera- 
tion to  total  machine  hours,  when  the  machine  rather  than 
the  individual  is  the  measure  of  such  expense. 

51.  Before  considering  the  general  division  into  analy- 
tical bookkeeping  and  factory  cost  keeping  it  will  be  well 
to  take  up  certain  of  the  primary  steps  which  are  essential 
in  order  to  secure  correct  results.  These  steps,  which  are 
common  to  both  systems,  relate  to  the  methods  for  record- 
ing elemental  costs. 

52.  Practically  every  producing  concern  or  organiza- 
tion has  its  storehouses — that  is,  buildings  or  rooms  to 
which  property  is  sent  when  purchased  or  w^hen  secured 
in  any  other  way,  where  it  is  kept  until  called  for,  and 
whence  it  is  issued  as  needed  for  production  purposes.  The 
organization  should  therefore  have  stores  accounts  or  per- 


406  PRIMER  ON  COST  KEEPING 

jDetual  inventory  records,  witli  an  account  in  both  quanti- 
ties and  values  for  every  article  or  class  of  articles  carried 
in  such  store.  Such  record  should  be  in  the  form  of  a  ledger 
account,  and  usually  a  ledger  card  or  loose-leaf  ledger  will 
be  found  best  adapted  to  this  purpose.  This  record  should 
show  the  quantities  and  values  of  the  receipts  and  issues. 

53.  The  debit  postings  to  this  stores  ledger  will  be  made 
from  the  approved  vouchers  covering  purchases,  when  such 
approved  vouchers  are  always  prepared  immediately  upon 
receipt  of  articles  purchased,  or  from  commercial  invoices 
if  approved  vouchers  are  not  prepared  until  some  time 
thereafter,  and  from  other  approved  vouchers,  covering 
these  other  elements  of  expense  principally  for  services 
of  various  kinds  heretofore  referred  to  (par.  38)  as  form- 
ing a  part  of  the  cost  of  stores.  When  these  debit  post- 
ings are  made  from  the  receipted  invoices  there  should  be 
a  suspense  account  credited  therewith  to  be  debited  with 
the  same  amount  when  the  voucher  is  approved  and  paid. 
In  practice  it  will  probably  develop  that  the  purchase  price 
and  transportation  by  freight  or  express  are  the  only  items 
which  can  be  charged  directly  on  the  accounts  for  the  va- 
rious items  of  stores  and  that  a  sufficient  percentage  to 
cover  the  other  expenses  must  be  added  to  the  foregoing 
to  get  a  total  cost  charge  for  each  article  of  stores.  When 
the  articles  of  stores  are  of  greatly  differing  nature  and 
the  expenses  vary  greatly,  it  may  be  necessary  to  classify 
all  the  articles  of  stores  and  fix  different  percentages  for 
this  loading  of  the  several  classes. 

54.  The  credit  postings  to  this  stores  ledger  will  be 
made  from  requisitions,  sometimes  called  material  bills  or 
cards,  drawn  by  or  by  direction  of  those  in  charge  of  the 
various  operations.  Such  requisitions  should  usually  be  in 
duplicate,  and  should  show  the  quantity,  unit  price,  and 
gross  cost  for  the  stores  supplied  upon  it.  They  should 
also  show  for  what  purpose  the  articles  are  wanted,  as 


PRIMER  ON  COST  KEEPINa  407 

hereafter  set  out  in  discussing  the  two  systems  of  cost 
accounting. 

55.  When  articles  of  property,  either  in  the  form  of 
raw  material  or  as  partly  finished  stock,  are  transferred 
from  one  branch  of  the  organization  to  another  or  returned 
to  the  storehouse,  the  record  of  such  transaction  should 
be  made  upon  a  requisition.  For  convenience,  the  record 
of  such  transfer  is  often  given  some  other  designation,  as 
** material  invoice,"  *' property  transfer,"  etc.,  but  by  what- 
ever term  it  is  known  it  is  a  requisition  in  the  broad  sense, 
i.  e.,  the  order  which  secures  and  records  the  movement 
of  stores  within  an  organization. 

56.  The  balance  shown  on  the  stores  ledger  w^ill  pre- 
sumably represent  the  quantities  on  hand  in  the  stores, 
and,  if  it  does,  it  will  verifj^  the  amounts  of  the  issues  as 
credited  thereon  and  correspondingly  debited  to  the  work 
for  which  they  were  supplied.  The  labor  and  trouble  in- 
volved in  making  an  actual  physical  inventory,  however, 
should  not  be  permitted  to  excuse  the  omission  of  such 
stock  taking.  The  verification  of  receipts  for  which  pay- 
ment is  to  be  made  must  of  course  be  made  in  order  to 
certify  the  proper  vouchers ;  but  receipts  for  which  no  pay- 
ment is  to  be  made,  as  of  articles  transferred  from  one 
arsenal  to  another,  or  to  or  from  a  warship  and  a  nasy- 
yard,  should  be  checked  as  carefully  for  both  quantities 
and  values. 

57.  The  verification  of  the  stores  on  hand  may  be  ac- 
complished in  any  one  of  several  wa3^s: 

A.  At  times  when  because  of  legislation  or  regulation  a  change  takes 

place  in  the  status  of  stores. 

B.  At  times  when  it  is  known  that  the  supply  of  certain  articles  is  low. 

C.  At  arbitrary  dates,  either  for  the  entire  stock  once  or  twice  a  year, 

or  preferably  on  successive  dates  for  dififerent  classes  of  articles. 

58.  Individual  labor,  whether  of  men  or  animals,  should 
be  recorded  by  some  kind  of  time  book,  either  solidly  bound 
or  loose-leaf,  or  some  kind  of  work-report  slips,  showing 
the  name  and  number  of  the  employe,  his  designation,  time 


408  PRIMER  ON  COST  KEEPING 

employed  or  quantity  of  work  performed,  unit  for  payment 
and  rate,  total  earnings  and  references  to  the  particular 
work  upon  which  employed.  From  such  time  records  pay- 
rolls or  service  vouchers  will  be  prepared  and  the  time 
records  should  be  of  such  a  character  as  to  admit  of  the 
entire  amount  of  the  pay-roll  therefor  being  charged  direct 
to  the  product  on  which  the  work  was  done. 

59.  When  the  work  on  the  products  extends  over  long 
periods  of  time,  the  cost  of  the  lost  time  should  be  deter- 
mined in  whole  or  in  part  at  the  end  of  the  fiscal  or  calendar 
year,  or  on  other  fixed  dates,  and  the  charges  made  for 
actual  time  lost  and  generally  prorated  on  the  basis  of  the 
cost  of  the  productive  and  non-productive  labor.  If,  how- 
ever, it  is  necessary  for  any  reason  to  obtain  the  cost  of 
any  part  prior  to  the  regular  time  for  distribution  of  the 
cost  of  lost  time,  the  estimate  for  it  may  be  made  as  here- 
after indicated  for  job  work.  Wlien  the  product  is  in  the 
nature  of  job  work  for  which  charges  must  be  made  on 
completion  of  the  work  or  shortly  after,  a  percentage  should 
be  added  to  the  cost  of  the  productive  and  non-productive 
labor  chargeable  to  the  work  as  an  estimated  equitable 
charge  for  lost  time. 

60.  Bulk  services,  furnished  by  the  job,  etc.,  will  usu- 
ally be  re]Dorted  in  the  form  of  a  commercial  invoice  to 
be  thereafter  vouchered  and  from  which  the  proper  entries 
may  be  made  charging  the  accounts  for  which  the  service 
Avas  rendered. 

61.  Reports  of  the  quantities  and  varieties  of  the  com- 
pleted output  are  as  essential  as  records  of  the  stores 
and  services  which  have  become  a  charge  to  it,  and  must 
be  returned  with  the  same  regularity  and  carefulness.  In 
continuous  process  factories,  when  operated  under  normal 
and  uniform  conditions,  the  quantities  of  the  marketable 
product  may  be  sufficient,  upon  the  assumption  that  the 
quantity  of  partly  finished  stock  at  the  end  of  the  period 
was  the  same  as  the  quantity  at  the  beginning  of  said  pe- 


PRIMER  ON  COST  KEEPING  409 

riod.  If  the  conditions  of  operations  are  changing  greatly, 
or  if  the  product  is  the  output  of  varied  process  factories, 
the  reports  must  show  the  entire  accomplishment  both  in 
completed  and  partly  completed  stock. 

62.  Having  discussed  the  methods  applicable  to  making 
a  sufficient  record  of  the  elemental  costs  and  the  quantity 
of  product,  it  now  remains  to  describe  the  two  systems 
for  combining  the  records  of  such  elemental  costs. 

63.  The  productive  work  of  practically  every  produc- 
ing concern  is  done  through  a  series  of  operations.  It  is 
a  difficult  task  to  group  these  into  general  classes.  Pos- 
sibly a  fairly  comprehensive  and  representative  grouping 
would  be  as  follows:  Stores,  incidental  operations,  produc- 
tive operations,  marketing  operations,  administration.  An 
example  from  the  government  service  is  found  in  the  Bu- 
reau of  Engraving  and  Printing.  Limited  to  its  produc- 
tion of  postage  stamps  its  operations  when  grouped  ac- 
cording to  the  foregoing  classification  are  about  as  follows : 

Stores — Materials,  supplies,  and  plant. 

Incidental  operations — Engraving,  power,  care  of  building. 

Productive  operations — Wetting,  printing,  gumming,  perforating,  cut- 
ting, inspecting. 

Marketing  operations — Packing,  carting. 

Administration — Superintendence,  ordering,  accounting,  watch  and 
messenger  service. 

64.  A  class  of  organizations  to  which  analytical  book- 
keeping is  especially  adapted  as  a  system  for  determining 
the  costs  of  various  portions  of  the  work  is  that  of  the 
scientific  or  investigating  bureaus.  The  work  of  such  or- 
ganizations will  often  occasion  as  necessary  component 
parts  thereof  the  following  practically  independent  opera- 
tions : 

Stores — Necessary  supplies. 

Incidental  operations — Mailing  requests  for  information. 

Productive     operations — Field     investigations,     office     investigations, 

laboratory  work,  computing,  editing. 
Marketing  operations — Printing,  packing,  shipping. 
Administration — Superintendence,  clerical,  messenger. 

65.  It  has  already  been  stated  (par.  20)  that  when  the 


410  PRIMER  ON  COST  KEEPING 

product  is  measurable  in  bulk  and  not  usually  divided  into 
separate  units,  a  system  of  analytical  bookkeeping  is  suffi- 
cient if  an  analysis  of  the  expenses  has  been  made  accord- 
ing to  the  purpose  of  the  expenditures.  Such  analysis 
should  be  according  to  the  immediate  object  or  purpose 
to  be  accomplished  rather  than  according  to  the  nature 
of  the  particular  expenditure.  The  latter  classification  is 
also  valuable  in  deteiinining  the  elements  of  cost,  but  the 
former  classification,  showing  for  what  operation  the  ex- 
penditure was  incurred  is  the  more  important.  Ledger 
headings,  or  controlling  accounts,  should  be  provided  for 
each  of  the  general  operations  and  subdivided  as  far  as 
experience  shows  is  profitable.  For  these  accounts,  short, 
appropriate  titles  may  be  selected,  or  a  system  of  symbols, 
using  letters  or  figures,  or  both,  may  be  adopted.  The  for- 
mer is  probably  surer  in  accuracy  of  the  record  work;  the 
latter  is  the  simpler  in  the  amount  of  such  work,  and  if 
handled  carefully  can  be  profitably  employed. 

66.  The  distinguishing  feature  of  factory  cost  keeping 
is  that  the  individual  costs  of  the  various  items  of  prod- 
uct are  not  obtained  from  the  general  ledger,  but  are  col- 
lated in  some  sort  of  cost  ledger,  the  total  charges  to  which 
should  equal  the  totals  of  the  charges  to  the  several  depart- 
mental, operating,  or  controlling  accounts  in  the  general 
ledger.  An  analysis  of  the  operations  of  the  business  and 
a  separation  into  classes  is  necessary,  as  indicated  for  an- 
alytical bookkeeping,  and  the  expenses  for  each  should  be 
charged  to  its  appropriate  account.  But  when  the  product 
is  varied  in  nature  and  requires  at  times  only  one  opera- 
tion, at  times  two,  and  again  all,  or  nearly  all,  it  becomes 
impracticable  to  secure  accurate  costs  by  any  system  of 
prorating.  It  then  becomes  necessary  to  open  an  account 
in  the  cost  ledger  to  w^hich  shall  be  charged  all  expenses 
incurred  for  that  particular  item  of  product. 

67.  The  basis  for  the  factory  cost-keeping  system  is 
the  production  order,  otherwise  styled  a  job  order,  shop 


PRIMER  ON  COST  KEEPINa  411 

order,  work  slip,  fabrication  order,  etc.    It  serves  several 
purposes,  as  follows: 

A.  It  alone  is  the  means  employed  to  initiate  work  upon  a  particular 

unit  or  group  of  units  of  output. 

B.  It   authorizes    the   heads    of    departments    of   the    organization    to 

secure  necessary  quantities  of  stores,  which, are  charged  thereto, 
and  makes  proper  record  of  disposition  of  the  services  of  em- 
ployes. 

C.  It  bears   a  number  by  which  all  raw  material  and   partly  manu- 

factured stock  therefor  is  known. 

D.  It,   or   some   accompanying  work   report    or   subproduction    order, 

collects  the  quantities  of  services  applied  to  the  production  of  the 
output. 

E.  It  becomes  a  part  of  the  loose-leaf  cost  ledger  or  is  the  journal  from 

which  postings  are  made  to  the  cost  ledger  if  kept  in  any  other 
way. 

68.  This  is  actually  the  title  of  an  account  in  the  general 
ledger  covering  certain  general  classes  of  expense,  usually 
more  or  less  uniform,  within  different  periods  of  like  dura- 
tion. Such  expenses  are  usually  those  for  the  incidental 
operations  necessary  to  the  progress  of  the  directly  produc- 
tive operations.  The  accounts  necessary  will  often  be  those 
for  enlargement  or  betterment  of  plant,  increase  of  equip- 
ment, renewals  of  plant  or  equipment,  power,  heating,  light- 
ing, care  of  building,  etc. 

69.  Costs  to  a  contractor  on  private  and  corporate  work 
are  now  frequently  determined  in  the  interests  of  the  party 
for  whom  the  work  is  performed.  Construction  work  under 
the  Government  is  generally  done  by  contract.  In  such 
case  it  is  desirable,  as  a  rule,  to  determine  two  costs  for 
the  work — first,  to  the  Government,  and  second,  to  the 
contractor.  The  reasons  for  the  determination  of  such 
costs  are  to  furnish  information  in  regard  to  (A)  the  profits 
or  losses  of  the  contractor;  (B)  the  probable  ability  of  the 
contractor  to  complete  his  contract;  and  (C)  unit  costs 
which  are  of  value  in  determining  estimates  of  cost  and 
reasonableness  of  bids  for  future  similar  work. 

.70.  The  methods  employed  in  collecting  contractors' 
costs  are  those  which  pertain  to  ordinary  construction 
work  with  such  variations  as  may  be  necessary  in  each 


412  PRIMER  ON  COST  KEEPING 

case.  Statistics  of  productive  labor,  materials,  and  sup- 
plies are  collected  by  inspectors.  Unit  prices  pertaining 
thereto  may  be  assumed  at  market  rates,  or,  if  the  contract 
requires  it,  as  is  frequently  the  case,  the  contractor  may 
be  requested  to  furnish  these  and  other  data  which  cannot 
be  readily  collected  by  inspectors.  It  may  be  necessary 
and  desirable  to  estimate  many  of  the  details  of  such  costs. 
For  example,  in  the  case  of  horses  owned  by  the  contractor 
it  is  frequently  more  satisfactory  to  reckon  the  cost  of 
their  work  on  the  basis  of  current  rates  for  hiring  animals 
rather  than  to  determine  the  cost  of  maintaining  them  and 
to  estimate  depreciation,  etc. 

71.  Since  the  details  of  the  collection  and  estimating 
of  contractors'  costs  vary  with  conditions,  they  should  be 
fully  described  in  each  case.  The  costs  as  reported  should 
also  be  divided  into  two  parts,  (A)  those  which  are  deter- 
mined accurately  and  (B)  those  which  are  estimated.  The 
accompanying  explanations  should  be  so  complete  that 
other  persons  using  the  data  may  be  able  to  judge  their 
value  and  the  limits  of  their  accuracy. 

72.  Periodical  Literature. — In  the  July,  1904,  issue  of 
the  Engineering  Magazine  (vol.  xxvii,  p.  643)  there  was 
printed  "An  Index  of  the  Literature  of  Industrial  En- 
gineering," containing  references  to  over  eighty  articles 
on  cost  keeping;  and  also  lists  of  articles  on  "Deprecia- 
tion," "Wage  systems,"  and  "General  management." 
Many  articles  of  value  have  appeared  since  that  date  in 
various  trade  and  accounting  journals,  among  which  spe- 
cial attention  should  be  called  to  three  papers  on  "Cost 
keeping  on  contract  work,"  by  A.  W.  Buel,  in  the  March, 
May,  and  June,  1905,  issues  of  the  Engineering  Magazine 
(vols,  xxviii  and  xxix).  It  is  to  be  hoped  that  such  indexes 
of  the  periodical  literature  on  the  subject  may  be  pub- 
lished regularly. 

73.  Permanent  Literature. — There  follows  a  list  of 
books  relating  to  cost  keeping  and  kindred  matters,  which 


PRIMER  ON  COST  KEEPING  413 

is  believed  to  be  a  fairly  complete  bibliography    of   the 
subject: 

74.    Co^  Keeping  and  Business  Organization — 

On  the  Economy  of  Machinery  and  Manufactures.     Charles  Babbage, 

A.  M.     Charles  Knight,  London.     1832. 
Cost  of  Manufactures  and  the   Administration  of  Workshops.     Capt. 
Henry  Metcalf.  Ordnance  Dept.,  U.  S.  A.     John  Wiley  &  Sons, 
New  York.     1885. 

Factory  Accounts.    Emile  Garcke  and   J.   M.   Fells.     Crosby  Lockwood  & 

Sons,  London.     1887. 
Cost    Accounts.      Walter    Strachan,    Inc.    Acct.      Stevens    &    Haynes, 
London.     1893. 

Commercial  Organization  of  Factories.     J.  Slater  Lewis.     E,  &  F.  N. 
Spon,  London.     1896. 

Commercial  Management  of  Engineering  Works.     Francis  G.  Burton. 
Scientific  Publishing  Co.,  Manchester.     1898. 

Management  of  Engineering  Workshops.     Arthur  H.  Barker.     Tech- 
nical Publishing  Company,  Manchester.     1899. 

Engineering  Estimates  and  Cost  Accounts.    Francis  G.  Burton.    Tech- 
nical Publishing  Co.,  Manchester.     1900. 

Complete  Cost  Keeper.     Horace  Lucian  Arnold.     Engineering  Maga- 
zine Co.     1900. 

Cost  Accounts  of  an  Engineer  and  Iron  Founder.    J.  W.  Best,  F.  C.  A. 
Gee  &  Co.,  London.     1900. 

Cost  Accounts.     C.  A.  Millener.     Hunter-Rose  Co.,  Toronto.     1901. 

Cost  of  Production.     Charles  J.  Watts.    Shaw- Walker  Co.,  Muskegon. 
1902. 

Engineers  and   Shipbuilders'  Accounts.     Francis   G.   Burton.     Gee  &  Co., 
London.  1902. 

Contract  Accounts.     Everett  Audit  Co.    Published  for  McArthur  Bros. 
Co.,  Chicago.     1902. 

Factory  Manager  and  Accountant.    Horace  Lucian  Arnold.    Engineer- 
ing Magazine  Co.,  New  York.     1903. 

Manufacturers'    Accounts.      W.    C.    Eddis,    F.    C.    A.,   and   William    B. 
Tindall,  A.  C.  A.     Published  by  the  Authors,  Toronto.     1904. 

Manufacturing    Cost.      H.    L.    C.    Hall.      Bookkeeper    Publishing    Co., 
Detroit.     1904. 

Workshop   Costs   for   Engineers   and   Manufacturers.     Sinclair   Pearn 
and  Frank  Pearn.     1904. 

Builders'  Accounts.    John  Arthur  Walbank.     Gee  &  Co.,  London.  1904. 

Cost  Accounts.     L.  Whittem-Hawkins.     Accountancy  Publishing  Co., 
New  York.     1905. 

Business  Features  of  Engineering  Practice.     A.  C.  Humphreys,  M.  E. 
Stevens  Institute  of  Technology.  Hoboken.     1905. 

Cost  of  Production.     Bert  Clifford  Bean.     System  Co.,  Chicago.     1905. 

Organizing  a  Factory.    Clinton  E.  Woods.    System  Co.,  Chicago.  1905, 

75.    Depreciation — < 

Depreciation  of  Factories  and  Their  Valuation.    Ewing  Matheson.    E. 

&  F.  N.  Spon,  London.     1884. 
Depreciation    Reserves   and    Reserve   Funds.     Lawrence    R.    Dicksee. 

Gee  &  Co.,  London.    1903. 


414  PRIMER  ON  COST  KEEPING 

76.   Wage  Systems- 
Profit-sharing  Between  Capital  and  Labor.    Sedley  Taylor,  M.  K. 

Kegan  Paul,  Trench  &  Co.,  London.     1884. 
Profit-Sharing  Between  Employer  and  Employe.     Nicholas  Paine  Gil- 
man.    Houghton,  Mifflin  &  Co.,  New  York  and  Boston.    1889. 
Bargain  Theory  of  Wages.     Professor  Davidson.     Rutgers  College, 
New  Brunswick.    1898. 


SOME  PRINCIPLES  OF  COST  ACCOUNTINa* 

BY  ERNEST  RECKITT,  C.  P.  A. 

In  the  choice  of  a  subject,  I  have  been  influenced  not 
only  by  the  growing  demand  on  the  part  of  manufacturers 
for  intelligent  men  in  their  cost  departments,  but  also  by 
the  necessity  of  a  greater  appreciation  of  correct  principles 
in  the  application  of  "costs."  Many  business  men  have 
unfortimately  lost  faith  in  the  benefits  to  be  derived  from 
maintaining  a  cost  department,  and  it  has  been  my  expe- 
rience that  usually  in  such  cases  the  failure  of  the  system 
has  been  due  to  illogical  methods  and  a  failure  to  bring 
the  information  which  should  be  prepared  by  this  depart- 
ment in  concise  form  before  the  superintendent  and  general 
manager.  Thus,  it  is  no  uncommon  thing  to  find  the  total 
factory  expense  apportioned  on  the  basis  of  the  prime  cost 
of  the  complete  machines,  instead  of  determining  the  fac- 
tory expense  of  each  department  and  apportioning  same 
on  the  parts  manufactured  by  that  department.  Where 
the  factory  output  consists  of  a  variety  of  machines  and 
where  the  factory  expense  of  some  departments  is  much 
heavier  than  in  others,  it  will  be  readily  seen  that  the  latter 
plan  is  the  only  one  which  could  give  accurate  results. 

Before  entering  upon  the  discussion  of  what  constitutes 
factory  or  manufacturing  cost,  it  is  advisable  ^  that  you 
should  have  a  clear  understanding  of  certain  of  its  fea- 
tures, and  the  first  that  I  will  call  your  attention  to  is  that 
of  Eental. 

The  actual  owTiership  of  a  plant,  that  is,  the  real  estate, 
buildings,  boilers  and  engines,  is  not  essential  in  order  to 
manufacture.  Not  only  can  plants  be  rented,  but  the  power, 
light  and  heat  can  be  purchased   from   outside   vSources. 


Reproduced  from  Journal  of  Accountancy. 

*15 


416  ERNEST  RECKITT 

Therefore,  if  a  manufacturer  decides  to  invest  the  whole 
or  part  of  his  surplus  capital  in  real  estate,  plant,  etc.,  and 
erect  his  own  power,  light  and  heat  plant,  he  is  actually 
engaging  in  other  enterprises  not  absolutely  essential  to  the 
manufacture  of  the  articles  he  sells.  As  an  illustration,  we 
may  suppose  a  concern,  that  for  the  sake  of  convenience 
we  will  call  the  Smith  Mfg.  Co.,  having  a  capital  of  $150,- 
000.00,  whose  net  profits  amount  to  $30,000.00,  and  who 
pay  an  annual  rental  of  $9,000.00  to  a  Mr.  Brown  on  prop- 
erty valued  at  $100,000.00.  It  is  fair  to  assume  that  Mr. 
Brown  pays  out  in  taxes,  insurance  and  repairs  the  sum 
of,  we  will  say,  $2,000.00  a  year  and  makes  a  reserve  for 
depreciation  at  the  rate  of  2  per  cent  per  annum  or  $2,000.- 
00,  leaving  a  net  available  profit  to  himself  of  $5,000.00,  or 
5  per  cent  on  his  investment  of  $100,000.00. 

The  question  arises  whether  it  would  be  a  good  invest- 
ment for  the  Smith  Mfg.  Co.  to  own  its  own  real  estate 
and  plant,  or  whether  it  would  be  wiser  to  continue  to 
rent.  If  they  purchase  the  premises  for  $100,000.00  out  of 
their  earnings,  they  will  then  have  an  invested  capital  of 
$250,000.00,  producing  profits  amounting  to  $35,000.00  per 
annum  or  14  per  cent  on  their  invested  capital,  while  prior 
to  that  time  their  profits  amounted  to  20  per  cent  on  a 
capital  of  $150,000.00.  Hence  it  will  be  seen  that  it  would 
be  folly  to  sink  $100,000.00  in  the  purchase  of  a  plant, 
unless  their  profits  produced  more  money  than  they  could 
advantageously  use  in  increasing  their  business,  or  unless 
it  was  considered  that  the  purchase  of  the  plant  was  a 
good  conservative  investment.  But  the  $100,000.00  so  in- 
vested could  have  been  used  to  purchase  bonds  or.  other 
safe  securities  and  their  regular  and  legitimate  business 
would  have  gone  on  just  the  same.  It  is,  therefore  clear, 
that  if  a  company,  private  firm  or  individual  owns  its  own 
plant,  it  should  consider  it  as  a  matter  quite  outside  of 
the  investment  in  the  manufacturing  business,  and  should 
charge  the  latter  with  rent,  so  that  the  true  percentage 


COST  ACCOUNTINa  417 

of  profit  on  the  articles  manufactured  can  be  arrived  at. 
Furthermore,  in  nearly  all  factories  it  is  found  necessary, 
to  establish  departments,  one  department  manufacturing 
one  part  of  the  mechanism  or  articles  dealt  in,  while  an- 
other department  carries  out  other  operations.  Each  de- 
partment should  be  charged  with  its  proper  proportion  of 
rent,  and  this  same  plan  is  sometimes  carried  still  further 
by  charging  each  machine  with  its  proportion  of  rental 
charges.  Thus  the  cost  of  operating  a  large  steam  hammer 
in  respect  to  space  occupied  would  be  very  much  larger 
than  that  of  a  small  drill  used  in  conjunction  with  special 
tools. 

To  determine  the  rental  chargeable  by  a  concern  own- 
ing its  own  real  estate  and  plant,  it  is  necessary  to  open  in 
the  general  ledger  an  account  to  be  termed  Real  Estate 
Operating  Account,  and  to  charge  this  account  with  the 
following  items : 

(1)  Eeal  Estate  Taxes, 

(2)  Fire  Insurance  on  Buildings, 

(3)  Repairs  to  Buildings, 

(4)  Depreciation  on  Buildings, 

(5)  Interest  at  5  per  cent  or  6  per  cent  per  annum  on 
the  amount  invested  in  Real  Estate  and  Buildings, 

— and  to  credit  this  account  and  charge  the  various  depart- 
ments each  with  its  proportionate  amount  which  in  the 
aggregate  will  equal  the  total  debits.  To  make  this  clearer 
I  have  drawn  up  the  following  statement  as  illustrating 
a  Real  Estate  Operating  Account: 

DEBITS  CREDITS 

Real  estate  taxes $    500.00  Distribution  to  Departments: 

Fire  insurance 1,000.00       Chargeable  to  Dept.  A $5,000.00 

Repairs    500.00       Chargeable  to  Dept.  B 1,500.00 

Depreciation     2,000.00      Chargeable  to  Dept.  C 3,500.00 

Interest  at  5%  on  investment  5,000.00  Chargeable  to  power  plant. . .      500.00 

Chargeable  to   administration 

$9,000.00  expense  for  office  bldg 500.00 


$9,000.00 


The  charge  appearing  in  the  above  account  representing 

B— VIII— 27 


418  ERNEST  RECKITT 

interest  at  5  per  cent  on  the  investment  in  real  estate  and 
buildings  should  be  credited  to  a  real  estate  profit  and  loss 
account. 

The  next  item  of  factory  cost  that  requires  comment 
is  depreciation.  It  is  not  my  object  to  treat  fully  of  de- 
preciation, as  to  do  so  would  demand  a  lengthy  paper  on 
this  subject  alone,  but  merely  to  point  out  its  importance. 
Depreciation  may  be  said  to  be  the  gradual  diminution  in 
value,  due  to  wear  and  tear,  obsolescence,  or  other  causes, 
of  what  are  termed  fixed  assets,  such  as  leases,  patents, 
buildings,  machinery,  etc.  I  believe  it  was  John  Mann, 
C.  A.,  of  Glasgow,  who  said  that  the  application  of  the 
principles  involved  by  the  term  depreciation  is  merely  an 
acknowledgement  of  that  universal  law  that  nothing  around 
us  is  eternal,  and  that  sooner  or  later  everything  must  suc- 
cumb to  the  destructive  forces  of  the  elements  or  to  change 
of  conditions. 

Closely  allied  to  depreciation  is  the  item  of  extraordi- 
nary repairs.  We  will  suppose  that  a  factory  has  been 
built  and  new  boilers,  engines  and  machinery  installed.  It 
is  reasonable  to  expect  that  during  the  first  year  the  re- 
pairs will  be  exceedingly  light;  during  the  second  year, 
somewhat  heavier;  during  the  third  year,  still  greater;  until 
it  may  be  the  fourth  year  and  after,  before  the  repairs 
to  the  machinery  appear  to  cost  approximately  the  samei 
each  year.  Yet  it  is  only  fair  that  the  first  and  second 
years'  business  should  be  chargeable  with  a  part  of  the 
repairs  made  during  succeeding  j^ears,  as  it  is  the  wear 
and  tear  of  these  years  that  has  largely  been  instrumental 
in  causing  the  outlay  in  the  third  and  fourth  years.  For 
this  reason  it  is  proper  and  conservative  to  charge  the  first 
and  second  years  with  an  estimated  amount  to  cover  re- 
pairs to  be  made  in  the  future  and  to  credit  a  reserve  ac- 
count which  in  later  years  may  be  used  to  lessen  the  charge 
to  profit  and  loss  for  this  form  of  outlay. 

While  it  is  perhaps  scarcely  within  the  scope  of  this 


COST  ACCOUNTING  419 

article,  I  would  state  that  no  factory  accounts  are  complete 
without  a  system,  preferably  a  card  system,  for  recording 
all  the  machinery  in  stock.  There  should  be  a  card  for 
each  machine,  filed  in  the  case  in  such  a  manner  that  its 
location  in  the  factory  can  be  immediately  determined.  If 
the  machine  be  moved  from  one  room  to  another  the  card 
is  similarly  changed  to  another  sub-division  in  the  case. 
Each  machine  should  be  numbered,  the  corresponding  num- 
ber being  entered  on  the  card,  in  addition  to  which  the  card 
should  show: 

(1)     Description  of  machine. 

'(2)     Date  of  Purchase. 

[(3)     From  Whom. 

i(4)     Original  Cost. 

,(5)     Freight  Paid  and  Cost  of  Installment. 

'(6)'    Amount  of  Depreciation  Written  Off  Each  Year. 

(7)  Date  Scrapped. 
On  the  other  side,  the  card  should  record  cost  of  all  repairs 
made,  so  that  a  complete  history  of  each  machine  can  be 
obtained  by  the  factory  superintendent.  When  the  repairs 
to  the  machine  pass  beyond  a  certain  point,  this  fact  can 
be  ascertained,  and  a  decision  reached  as  to  whether  or 
not  it  would  be  cheaper  to  send  the  machine  to  the  scrap 
heap. 

Having  dealt  with  some  features  of  factory  costs  which 
require  more  careful  study  than  such  items  as  cost  of  ma- 
terial and  labor,  we  may  safely  pass  on  to  the  subject  of 
what  constitutes  factory  cost  and  of  other  definitions  of 
terms  used  in  this  connection. 

The  terminology  of  this  subject  is  in  a  very  chaotic 
condition,  this  being  due  largely  to  the  fact  that  the  science 
of  factory  costs  is  hardly  out  of  its  swaddling  clothes. 
Though  many  systems  of  factory  costs  have  been  brought 
up  to  a  high  state  of  perfection,  they  are  isolated,  and 
though  many  valuable  articles  as  well  as  books  have  been 
written,  each  person  has  pursued  this  investigation  along 


420 


ERNEST  RECKITT 


his  own  special  lines  and  there  does  not  appear  to  have  ever 
been  any  convention  of  those  interested  in  this  subject,  so 
that  a  nomenclature  and  definition  of  terms  which  would  be 
accepted  by  all  could  be  settled  for  all  time.  Thus,  that 
part  of  the  cost  of  manufacture  other  than  cost  of  material 
and  direct  labor  is  known  by  a  multitude  of  terms,  such  as, 
Factory  Expense,  Factory  Burden,  Overhead  Charges,  Gen- 
eral Expense,  Establishment  Charges  and  ''On  Cost."  To 
the  student  this  is  at  first  confusing,  until  he  realizes  that 
they  all  mean  one  and  the  same  thing.  Even  the  term 
**cost"  is  frequently  used  in  a  very  off-hand  manner,  some 
people  understanding  by  this  term  the  cost  of  manufacture 
and  not  total  cost,  including  the  cost  of  selling  and  admin- 
istration expenses,  while  others  again  might  understand  it 
to  be  the  cost  to  the  purchaser,  which  is  equivalent  to  the 
selling  price. 

Webster's  Dictionary  says  that  the  word  ''cost"  means 
"The  amount  paid  for  anything;  a  charge;  an  expense"; 
but  it  will  be  advisable  that  a  clearer  understanding  of 
what  cost  represents  should  be  had  before  going  any  fur- 
ther. It  is  important  that  we  should  know  what  are  the 
factors  that  enter  into  the  cost  of  any  manufactured  ar- 
ticle. In  the  following  diagram  I  have  attempted  to  show 
these  factors. 


'Factory  Cost    ' 


Cost 


"Prime  Cost 


Factory  Expense 


Material 


Direct  Labor 
[Direct  Factory  Expense 


.Selling  Cost 


rDistribution 


LAdministratioii 


1 


Indirect  Factory  Expense 


As  I  do  not  propose  in  this  article  to  enter  into  any  dis- 
cussion of  the  cost  of  selling,  you  will  note  that  the  sub- 


COST  ACCOUNTING  421 

ject  to  be  dealt  with  is  factory  costs,  or,  as  it  is  often 
termed,  cost  of  manufacture.  This  division  of  the  sub- 
ject is  a  rational  one,  for  there  is  a  distinct  line  of  demar- 
cation between  the  cost  up  to  the  point  of  placing  the  fin- 
ished product  in  the  stockroom  ready  for  shipment,  and 
which  involves  all  items  entering  into  cost  of  manufac- 
ture; and  the  cost  of  selUng,  which  includes  salaries  and 
commissions  to  salesmen,  traveling  expenses  of  salesmen, 
cost  of  packing  and  shipping  goods  from  stockroom  or 
warehouse,  cost  of  administration  in  salaries  to  officers 
and  clerical  staff  in  recording  sales  and  in  collection  of 
accounts  and  other  office  expenses  incidental  thereto. 

You  cannot  separate,  however,  prime  cost  from  fac- 
tory expense,  for  in  a  factory  there  cannot  be  such  a  thing 
as  prime  cost  without  factory  expense,  and  the  line  of 
demarcation  between  the  two  is  difficult  to  distinguish, 
and  can  only  be  carried  out  after  a  thorough  knowledge  of 
the  fundamental  principles  underlying  each. 

Generally  speaking,  we  may  define  prime  cost  as  that 
portion  of  the  cost  of  any  part  or  whole  of  a  mechanism 
or  material  manufactured,  that  can  be  absolutely  known 
as  chargeable  to  same  without  having  to  resort  to  estim- 
ates based  upon  percentages  or  any  other  more  or  less 
arbitrary  method.  Thus,  .in  the  simplest  system  of  fac- 
tory cost,  the  cost  of  two  ingredients  of  prime  cost  is  al- 
ways ascertainable,  namely,  cost  of  material  and  direct 
labor.  Direct  labor  is  the  term  used  to  designate  the  la- 
bor actually  spent  carrying  out  some  operation  on  the 
part  manufactured,  while  the  term  indirect  labor  repre- 
sents the  labor  which  it  is  impossible  to  charge  up  against 
any  one  part,  such  as  wages  paid  to  foremen,  inspectors, 
roustabouts,  etc. 

It  follows  that  the  most  accurate  costs  are  obtainable 
when  most  of  the  cost  of  manufacture  can  be  classified  un- 
der the  heading  of  prime  cost.  But  higher  civilization 
and  the  wonderful  development  of  machinery  as  a  substi- 


422  ERNEST  RECKITT 

tute  for  human  labor  is  making  the  proportion  of  cost  of 
manufacture  chargeable  to  prime  cost  become  smaller  and 
smaller  with  a  corresponding  increase  in  factory  expense. 
As  an  illustration  of  this  fact,  when  Robinson  Crusoe 
hewed  down  the  tree  from  which  he  made  his  canoe,  the 
cost  of  such  a  boat  was  all  direct  labor,  and  not  even  cost 
of  material  could  enter  into  the  calculation.  Under  a 
somewhat  higher  state  of  civilization  the  order  for  a  boat 
merely  necessitated  the  shipwright's  purchasing  some 
sound  oak  lumber  from  a  neighboring  farmer  and  with 
his  own  hands  building  the  boat.  In  this  last  case  you 
have  cost  of  material  and  direct  labor.  The  introduction 
of  machinery  has  changed  those  conditions,  and  what  was 
once  carried  out  by  human  hands  is  now  largely  accom- 
plished by  machinery,  so  that  the  prime  cost  of  an  article  is 
apparently  much  less  when  machinery  plays  a  part  than 
when  it  is  only  partially  used  or  not  at  all. 

It  is,  therefore,  clear  that  machinery  is  but  another 
form  of  labor,  and  that  the  cost  of  machine  labor,  or  what 
may  be  termed  ''machine  cost,"  is  a  part  of  prime  cost,  if 
it  can  be  accurately  determined.  I  have  gone  somewhat 
fully  into  this  phase  of  the  question  to  show  how  fine  a,  di- 
viding line  exists  between  prime  cost  and  factory  ex- 
pense; that  one  cannot  exist  without  the  other,  and  that 
the  division  between  the  two  is  in  reality  arbitrary. 

In  a  factory  where  there  is  more  than  one  department, 
it  is  customary  to  charge  each  department  with  its  par- 
ticular expenses  in  so  far  as  these  can  be  arrived  at,  and 
in  this  manner  to  calculate  more  accurately  the  cost  of 
each  particular  part.  When  factory  expense  can  be  thus 
accurately  distributed  between  departments,  it  is  termed 
direct  factory  expense,  and  those  expenses  which  it  is  im- 
possible to  distribute  as  between  departments  are  known 
as  indirect  factory  expense.  Here  again  we  find  it  diffi- 
cult to  make  any  exact  dividing  line  as  between  direct  and 
indirect  factory  expense;  for  what  in  one  plant  may  be 


COST  ACCOUNTING  423 

classified  as  direct,  becomes  indirect  factory  expense  at 
another  plant.  For  instance,  one  plant  may  possess  me- 
ters or  other  instruments  for  measuring  the  electricity  or 
other  motive  power  used  in  each  department,  while  an- 
other plant  may  contain  no  such  gauges,  and  in  this  latter 
case  the  cost  of  power  would  have  to  be  classified  as  in- 
direct factory  expense. 

From  the  above  remarks  I  now  call  your  attention  to 
the  following  table  showing  the  various  items  of  costs 
entering  into  the  total  cost  of  manufacture,  arranging 
them  as  far  as  possible  under  their  usual  classifications; 
but  it  must  be  borne  in  mind  that  in  so  far  as  the  distribu- 
tions under  direct  and  indirect  factory  expense  are  con- 
cerned, they  are  by  no  means  final: 

Prime   Cost: 

Material. 
Freight   In. 
Handling  Charges. 
Direct  Labor. 
Royalties. 

Direct  Factory  Expense: 

Rent. 

Abandoned  Tools. 

Defective  Parts. 

Supplies. 

Part  Indirect  or  Unproductive  Labor. 

Repairs  and  Replacements. 

Depreciation. 

Insurance. 

Taxes. 

Power  ^ 

Light     Hi  amount  to  each  department  can  be  ascertamed. 

Heat     J 

Indirect  Factory  Expense: 

Salary  of  Superintendent  and  part  Indirect  Labor. 

Shrinkage   in   Inventories.  ' 

Casualty   Insurance. 

Salaries  and  Supplies,  Cost  Dept. 

Salaries  and  Supplies.  Purchasing  Dept. 

Salaries  and  Supplies,  Stock  Dept. 

Salaries  and  Supplies,  Drafting  Dept. 

Power ") 

Light    f-If  no  separation  between  depattments  is  possible. 

Heat    J 

In  arriving  at  the  cost  of  power,  light  and  heat,  where 
all  of  such  items  are  manufactured  by  the  concern  operat- 


424  ERNEST  RECKITT 

ing  tlie  plant,  it  is,  as  stated  heretofore,  customary  to  con- 
sider the  power  plant  as  a  separate  institution  or  depart- 
ment, the  various  items  of  cost  entering  into  same  being 
shown  in  the  following  table: 

Power  Plant: 

Fuel. 

Supplies. 

Labor. 

Rent. 

Repairs  and  Replacements. 

Depreciation. 

Taxes  and  Insurance. 

Upon  ascertaining  the  cost  of  the  power  plant,  such 
cost  must  be  prorated  over  the  other  depaiitments  in  pro- 
portion to  the  amount  of  power,  heat  and  light  supplied. 

Having  discussed  the  various  items  of  cost  and  their 
nature,  the  next  step  is  a  consideration  of  how  to  apply  a 
knowledge  of  the  amount  in  the  aggregate  of  such  costs 
to  a  determination  of  the  cost  of  each  and  every  part  man- 
ufactured. 

Taking  up  first  prime  cost,  it  does  not  require  any 
large  amount  of  experience  to  see  that  the  cost  of  the  ma- 
terial is  based  upon  an  actual  measurement  of  the  mate- 
rial used  and  that  the  direct  labor  can  also  be  readily  com- 
puted from  the  daily  reports  of  employes.  Where  wages 
are  paid  by  piece  work,  it  will  be  seen  that  this  can  easily 
be  ascertained  by  adding  together  the  cost  of  each  oper- 
ation; and  where  employes  are  paid  upon  a  per  diem 
basis,  the  average  cost  per  operation  is  obtained  from  the 
daily  reports  which  show  the  number  of  good  parts  oper- 
ated and  manufactured  during  the  course  of  several  days. 

Factory  expenses,  whether  direct  or  indirect,  cannot 
be  calculated  in  this  exact  manner  and  various  methods 
are  in  use  for  prorating  these  expenses,  each  of  which 
has  its  advantages  in  special  cases.     These  methods  are: 

1.  A  rate  varying  with  quantity  of  material  handled, 

or  what  may  be  called  the  *'Unit  System.'^ 

2.  Percentage  on  prime  cost. 


COST  ACCOUNTING  425 

3.  Percentage  on  amount  of  direct  labor  in  money 

values. 

4.  Percentage  on  time  spent  by  direct  labor. 

5.  The  method  known  as  machine  cost. 

Quoting  from  the  article  on  this  subject  by  John  Mann, 
Jr.,  Chartered  Accountant,  of  Glasgow,  appearing  in  the 
Encyclopedia  of  Accounting: 

All  these  methods  should  bring  out  the  same  total  result,  that  is,  taking 
the  work  in  mass,  but  they  vary  much  in  accuracy  when  applied  to  depart- 
ments or  pieces  of  work.  Extraordinary  differences  emerge  under  the  various 
methods,  and  as  costing  becomes  more  minute  and  exact  the  selection  of  the 
best  method  of  distributing  expense  is  of  great  importance.  The  opinions  ex- 
pressed as  to  the  merits  of  these  systems  are  conflicting.  The  fact  is  that  each 
is  to  some  extent  a  compromise,  so  that  in  making  a  selection  the  peculiarities 
and  special  circumstances  of  each  industry  must  be  remembered.  It  may 
be  best  to  adopt  different  principles  in  different  classes  of  expenses  by  dif- 
ferent methods. 

To  those  of  you  who  desire  to  make  a  special  study  of 
this  subject  I  would  advise  a  careful  perusal  of  the  bal- 
ance of  this  article  in  the  Encyclopedia  of  Accounting.  I 
will  content  myself  with  a  few  comments  upon  each  meth- 
od. 

1.  The  Unit  System. — This  method  is  used  to  ad- 
vantage in  any  plant  or  business  where  the  product  is 
uniform,  such  as  breweries,  coal  mines,  flour  mills,  when 
the  commodity  is  sold  on  a  unit  basis.  Thus  the  factorj^ 
expense  is  divided  by  the  output  so  as  to  arrive  at  the  fac- 
tory expense  per  barrel  or  per  ton.  It  will,  however,  be 
seen  that  in  case  of  a  factory  turning  out  several  grades 
of  the  same  article,  such  as  a  flour  mill,  even  the  above 
method  of  distributing  could  not  be  used  without  taking 
into  consideration  some  other  factor,  which  would  charge 
a  greater  proportion  of  the  factory  expense  to  a  higher 
grade  than  to  the  lower  grade. 

2.  Percentage  on  Prime  Cost. — This  method  is  not  to 
be  recommended  except  in  small  concerns  where  an  elab- 
orate cost  system  is  not  practicable.  It  is  what  might  be 
termed  a  rough  and  ready  method,  and  is  one  which  is 
commonly  used  in  small  establishments,  as,  for  instance, 


426  ERNEST  RECKITT 

a  tailor's  shop,  where  it  is  customary  in  figuring  the  ex- 
pense of  making  a  suit  of  clothes  to  add  to  the  cost  of  the 
cloth  used  the  amount  of  labor  necessary  for  making  same, 
to  the  total  of  which  is  added  a  percentage  of  the  prime 
cost  to  cover  other  expenses  of  the  business.  In  this  way 
it  will  be  seen  that  a  man  ordering  a  more  expensive  cloth 
mil  be  really  paying  more  than  his  share  of  the  running 
expenses  of  the  business  compared  with  the  man  who  or- 
ders cloth  of  a  cheaper  texture.  This  method  of  distribut- 
ing factory  expense  is,  however,  very  commonly  used  by 
larger  concerns  and  erroneously  so,  as  it  leads  to  many  in- 
accuracies in  obtaining  accurate  costs. 

As  another  illustration  we  may  take  a  concern  dealing 
in  silverware  and  allied  goods.  In  the  particular  case  in 
point,  not  only  does  the  concern  manufacture  solid  silver 
spoons  but  also  silver-plated  ware.  The  cost  of  the  ma- 
terial in  one  case  is  very  much  higher  than  in  the  other, 
and  to  prorate  the  factory  expenses  on  the  basis  of  prime 
cost  will  result  in  two  evils;  fii^t,  the  cost  of  the  solid  sil- 
verware reported  by  the  cost  department  will  be  consider- 
ably higher  than  it  actually  is;  second,  the  reported  cost 
of  the  silver-plated  ware  will  be  considerably  less  than  it 
actually  is.  If  the  selling  prices  were  based  upon  such 
inaccurate  costs,  it  would  be  found  that  the  selling  prices 
of  solid  silverware  were  higher  than  those  of  their  com- 
petitors, with  the  result  that  they  would  lose  orders; 
while  in  the  case  of  the  silver-plated  goods,  their  prices 
would  be  lower  than  those  of  their  competitors,  with  the 
probable  result  that  they  would  be  inundated  with  orders, 
but  these  orders  would  bring  in  little  or  no  profit  to  the 
concern. 

3.  Percentage  on  Direct  Labor. — In  many  concerns 
this  method  is  popular  and  good,  but  it  is  not  applicable  in 
a  concern  which  manufactures  both  large  and  small  goods, 
involving  in  one  case  the  use  of  heavy  machinery  and  in 
the  other  a  number  of  small  machines.    Otherwise,  it  may 


COST  ACCOUNTING  427 

be  used  to  considerable  advantage,  as  the  cost  of  direct  la- 
bor in  any  part  or  mechanism  can  always  be  known,  and 
the  proportion  that  exists  between  the  total  factory  ex- 
pense and  the  total  direct  or  productive  labor  is  readily 
ascertainable.  It  is  not,  however,  an  advisable  method, 
unless  conditions  of  labor  remain  fairly  normal,  and  in  cas- 
es where  automatic  machinery  is  largely  used  this  method 
could  not  be  adopted,  inasmuch  as  such  machinery  is  tak- 
ing the  place  of  labor. 

4.  Percentage  of  Time  Spent  by  Direqt  Law. — Of  all 
the  methods  of  distributing  factory  expense  this  is  prob- 
ably the  most  scientific.  The  element  of  time  enters  very 
largely  into  most  of  the  fixed  expenses  of  a  business; 
therefore,  it  would  appear  that  factory  expenses  should  be 
distributed  on  the  basis  of  the  length  of  time  that  it  re- 
quires any  part  of  a  product  or  the  product  itself  to  be 
manufactured.  Under  this  plan  it  will  be  seen  that  an  em- 
ploye who  loafs  at  his  work  is  increasing  in  the  same  pro- 
portion the  amount  of  factory  expense  chargeable  to  the 
cost  of  the  product.  This  method,  therefore,  brings  out 
very  clearly  the  great  importance  of  speed  in  attaining  re- 
sults. A  case  to  illustrate  this  point  would  be  that  of  a 
large  office  building  which  is  to  be  constructed.  A  few 
years  ago  it  was  not  an  uncommon  thing  to  find  that  it 
took  two  years  to  erect  such  a  building;  now  it  is  the  ex- 
ception. We  see  a  whole  building  torn  down,  foundations 
laid,  the  steel  construction  erected  and  enclosed  with  ma- 
sonry and  brick,  and  the  whole  of  the  inside  of  the  build- 
ing completed  within  twelve  months.  The  cause  of  this 
great  activity  is  to  be  found  in  the  fact  that  the  interest 
on  the  money  lying  idle  in  the  first  case  is  twice  as  large 
as  in  the  second  case,  and  a  further  paving  by  securing  the 
erection  of  the  building  in  one  year  is  effected  b}^  the  fact 
that  one  year  after  starting  its  erection  the  building  is  oc- 
cupied and  earning  money.  The  value  of  the  interest  thus 
saved  is  such  an  important  factor  that  it  pays  to  expend 


428  ERNEST  RECKITT 

large  sums  of  money  for  overtime  to  mechanics  and  to  in- 
cur other  special  expenses  incident  to  obtaining  speed. 
The  same  principle  holds  equally  good  in  factories  where 
the  same  amount  of  interest  on  investment  and  many  of 
the  factory  expenses  go  on  the  same,  whether  the  factory 
be  running  full  blast  or  closed  down. 

5.  Machine  Costs. — In  this  article  I  have  frequently  al- 
luded to  the  fact  that  machinery  has  to  a  very  large  extent 
taken  the  place  of  what  prior  to  the  introduction  of  ma- 
chinery would  have  been  direct  labor.  I  have  also  stated 
that  the  most  accurate  costs  can  be  obtained  where  the 
predominance  of  the  cost  was  in  the  cost  of  material  and 
direct  labor,  leaving  only  a  small  amount  of  factory  ex- 
pense to  be  distributed.  It  follows,  as  machinery  is  only 
another  form  of  labor,  that  if  we  could  by  any  process  of 
figuring  compute  the  cost  of  the  machines  in  the  same 
manner  as  we  can  direct  labor,  we  should  then  arrive  at  a 
more  accurate  method  of  determining  costs.  This  is  just 
what  the  method  known  as  *' machine  costs"  attempts  to 
accomplish;  but,  of  course,  it  is  only  with  respect  to  ma- 
chinery that  carries  out  a  distinct  operation  on  a  part  man- 
ufactured that  this  method  can  be  used.  Thus,  traveling 
cranes,  shafting,  pulleys,  etc.,  cannot  come  under  this 
classification.  The  factors  that  enter  into  machine  costs 
may  vary  in  different  establishments,  but  in  any  case  they 
will  include  the  following: 

1.  Interest  on  Investmen^t. 

2.  Depreciation. 

3.  Repairs. 

To  these  factors  others  may  be  added,  and  should  be  add- 
ed if  they  are  obtainable,  such  as,  rent  of  floor  space  and 
amount  of  power  supplied.  On  arriving  at  the  cost  per  an- 
num of  each  of  the  above  factors  in  respect  to  a  machine, 
the  normal  number  of  hours  that  the  machine  will  work 
during  the  course  of  a  year  is  estimated  and  the  total  num- 
ber of  hours  during  the  year  is  then  divided  into  the  total 


COST  ACCOUNTING  429 

cost  per  annum,  and  in  this  way  we  arrive  at  what  may 
be  termed  machine  cost  per  hour.  By  adding  to  this  the 
cost  per  hour  of  direct  labor  for  the  man  employed  to  op- 
erate such  machine  or  machines  we  obtain  what  is  termed 
the  ''machine  rate."  It  will  thus  be  seen  that  in  calculat- 
ing the  cost  of  any  operation  a  great  deal  of  guesswork  in 
respect  to  certain  elements  of  factory  cost  are  thereby 
eliminated  and  a  more  accurate  knowledge  is  obtained  of 
the  cost  of  each  operation. 


SECTION   F 

PEOPLE  EX  REL.  MANHATTAN  RAILWAY  CO.  V. 

BARKER. 

[Court  of  Appeals  of  New  York.    June,  1895.     146  New  York,  304.]  ^ 

Cross-appeals  from  order  of  the  General  Term  of  the 
Supreme  Coui-t  in  the  first  judicial  department,  made 
April  11,  1895,  which  reversed  an  order  of  Special  Term 
vacating  and  setting  aside  an  assessment  of  the  relator's 
capital  stock  for  taxation  as  personal  property  for  the 
year  1894,  and  affirmed  the  proceedings  of  the  commis- 
sioner of  taxes  and  assessments. 

The  facts,  so  far  as  material,  are  stated  in  the  opinion. 

HAIGHT,  J.  On  the  8th  day  of  January,  1894,  the 
commissioners  of  taxes  and  assessments  of  the  city  of 
New  York  assessed  the  relator,  the  Manliattan  Railway 
Company,  for  its  personal  property  at  the  sum  of  $30,000,- 
000.  In  the  month  of  April  thereafter  the  relator  filed  a 
statement  upon  one  of  the  blank  forms  furnished  by  the 
department  of  taxes  and  assessments  showing  its  condi- 
tion on  the  second  Monday  of  January,  1894.  An  examin- 
ation of  the  treasury  of  the  company  was  thereupon  had 
by  the  commissioners,  who  then  reduced  the  assessment 
and  fixed  it  at  the  sum  of  $17,860,712.  The  relator  there- 
upon procured  a  writ  of  certiorari  directed  to  the  tax  com- 
missioners, commanding  them  to  make  return  of  the  pro- 
ceedings had  before  them  to  the  Special  Term  of  the  Su- 
preme Court  in  order  that  a  review  might  be  had  before 
that  court.  Upon  the  returns  so  made  by  the  commission- 
ers a  hearing  was  had  by  the  court  in  November,  1894, 
upon  which  an  order  was  entered  vacating  the  assessment. 
Upon  an  appeal  to  the  General  Term  this  order  was  re- 
versed and  the  assessment  as  made  reinstated. 

430 


SOME  JUDICIAL  DECISIONS  431 

In  1893  some  controversy  arose  over  tlie  amount  of  tHe 
assessment  of  the  relator's  personal  property,  which  re- 
sulted in  Mr.  Davies,  the  attorney  for  the  relator,  address- 
ing a  letter  to  the  commissioners,  in  which  he  states  that 
Mr.  Gould  had  authorized  him  to  say  that  if  the  assess- 
ment did  not  exceed  $12,500,000  they  would  acquiesce.  The 
statement  made  in  1893  has  some  slight  variations  from 
that  made  in  1894,  but  is  substantially  the  same  with  the 
exception  that  the  amount  of  surplus  reported  in  1894  is 
nearly  $1,000,000  in  excess  of  that  of  1893,  so  that  if  the 
commissioners  in  fixing  the  amount  of  the  assessment  for 
1894  acted  upon  the  statement  made  in  1893  as  compared 
with  that  made  in  1894,  and  the  letter  addressed  to  them 
by  Mr.  Davies,  they  could  not  well  have  increased  the  as- 
sessment in  1894  more  than  $1,000,000  or  thereabouts,  the 
amount  of  the  increase  of  the  surplus  earnings  of  the  com- 
pany. This  would  have  made  in  round  numbers  $13,500,- 
000.  It  was,  however,  stated  upon  the  argument  by  their 
counsel  that  a  very  different  method  was  adopted  in  reach- 
ing the  amount  of  the  assessment;  that  in  the  statement 
furnished  to  the  commissioners  the  assessed  value  of  the 
real  estate  had  been  given  at  $7,323,200,  and  no  mention 
had  been  made  as  to  its  actual  value,  and  that  the  com- 
missioners were,  therefore,  left  to  judge  for  themselves  as 
to  the  actual  value,  and  that  that  was  arrived  at  in  the  fol- 
lowing manner: 

Capital   Stock    $29,925,200 

Bonded    indebtedness     . . , 21,163,035 

Surplus     5,326,432 

Gross  assets    $56,414,667 

DEDUCTIONS. 

Assessed  value  of  real  estate   $  7,323.200 

Stock   in   other   companies    ". 7,075,200 

Mortgaged  indebtedness    21,163,035 

10  per  cent  of  the  capital  stock  2,992,520 

Total     , $38,553,955     $38,553,955 


432  SOME  JUDICIAL  DECISIONS 

Which    deducted    from    gross    assets,    leaves    amount 

assessable     $17,860,712 

The  actual  value  of  the  real  estate  as  assessed  is  thus 
ascertained  from  the  relator's  statement  by  deduct- 
ing from  the  gross  assets   56,414,667 

The  amount  of  its  personal  property,  consisting  of  roll- 
ing stock,  cash,   tools,   etc $3,748,315 

Stock  in  other  companies   7,075,200 

$10,823,315 


Leaving  as  the  actual  value  of  the  real  estate $45,591,352 

We  cannot  adopt  or  approve  of  this  method  of  ascer- 
taining the  value  of  the  relator's  personal  property  or  of 
the  actual  value  of  its  real  estate.  The  method  is  erro- 
neous and  incorrect  for  various  reasons.  Under  the  statute 
the  capital  stock  of  every  company  liable  to  taxation,  ex- 
cept such  part  of  it  as  shall  have  been  excepted  in  the  as- 
sessment roll  or  shall  have  been  exempted  by  law,  together 
with  its  surplus  profits  or  reserve  funds  exceeding  10  per 
cent  of  its  capital  after  deducting  the  assessed  value  of  its 
real  estate  and  of  shares  of  stock  in  other  corporations  ac- 
tually owned  by  such  company  which  are  taxable  upon 
their  capital  stock  under  the  laws  of  this  state,  shall  be 
assessed  at  its  actual  value  and  taxed  in  the  same  manner 
as  other  personal  and  real  estate  of  the  country  (Laws  of 
1857,  chap.  456,  sec.  3).  It  is  the  actual  value  of  its  cap- 
ital stock  and  not  the  market  value  of  its  share  stock  that 
is  to  be  assessed;  in  other  words,  it  is  its  actual  tangible 
personal  property  and  not  its  franchises.  Other  statutes 
provide  for  the  taxing  of  its  real  estate  and  franchises. 
(People  ex  rel.  The  Union  Trust  Co.  v.  Coleman,  126  N. 
Y.  433.)  The  real  property  of  the  relator  is  located  in  the 
city  of  New  York  under  the  eye  and  subject  to  the  inspec- 
tion of  the  commissioners.  Under  the  Revised  Statutes 
they  are  required  to  assess  it  at  its  just  and  full  value  as 
they  would  appraise  the  same  in  payment  of  a  just  debt 
due  from  a  solvent  debtor.  (1  R.  S.  393,  17.)  And  under 
the  Consolidation  Act  for  the  city  of  New  York  it  shall  be 
assessed  *'at  the  sum  for  which  such  property  under  or- 


SOME  JUDICIAL  DECISIONS  433 

dinary  circumstances  would  sell."  The  value  of  property 
is  determined  by  what  it  can  be  bought  and  sold  for,  and 
there  can  be  no  doubt  but  that  these  various  expressions 
used  in  the  statutes  all  are  intended  to  mean  the  actual 
value  of  the  property.  The  commissioners  are  sworn  of- 
ficers, and  as  such,  in  absence  of  evidence  to  the  contrary, 
are  presumed  to  have  done  their  duty.  They  have 
assessed  the  real  estate  at  $7,323,200,  and  yet,  under  the 
method  presented  by  their  counsel  for  ascertaining  the 
value  of  the  relator's  personal  property,  they  now  esti- 
mate the  actual  value  of  the  real  estate  to  be  $45,591,352. 
We  are  aware  that  it  is  generally  understood  that  in  man}" 
localities  throughout  the  state  assessors,  in  violation  of 
their  duties,  assess  the  real  estate  in  their  localities  at  a 
sum  less  than  its  actual  value,  but  in  the  absence  of  evi- 
dence that  this  has  been  done  by  the  commissioners  of 
taxes  and  assessments  in  the  city  of  New  York,  we  cannot 
assume  that  they  have  so  transgressed  for  the  purpose  of 
approving  of  their  work  in  this  case.  Real  property  can- 
not well  be  covered  up  or  hid  from  view.  Its  value  can 
readily  be  ascertained.  It  should  be  assessed  upon  estim- 
ates directly  made  as  to  its  value  and  not  upon  presump- 
tions figured  upon  intricate  theories. 

Again,  the  method  presented  by  respondents'  counsel 
involves  the  presumption  that  the  indebtedness  of  the  cor- 
poration represents  property  to  the  amount  of  such  in- 
debtedness in  addition  to  that  represented  by  its  capital 
stock.  This  presumption  cannot  be  indulged.  The  in- 
debtedness may  have  been  incurred  for  operating  expens- 
es, wages  of  employes  and  material  used  up.  It  may 
represent  property  worn  out,  decayed  or  burned  up  dur- 
ing the  existence  of  the  corpora^tion.  Presumptions  that 
arise  from  the  earnings  of  a  corporation  and  those  that 
arise  from  its  indebtedness  are  quite  different.  Too  many 
of  the  railroads  of  the  country  are  in  the  hands  of  receiv- 
ers to  v^arrant  a  judicial  presumption  that  the  bonded  or 

ii.VlIl— 28  w  J.  X 


434  SOME  JUDICIAL  DECISIONS 

other  indebtedness  of  each  road  represents  its  actual  tang- 
ible property  in  addition  to  that  represented  by  its  cap- 
ital stock. 

And  again,  the  method  proposed  necessarily  includes 
the  value  of  the  franchises  possessed  by  the  corporation 
which,  as  we  have  seen,  cannot  properly  be  included  in  the 
assessment  under  review. 

Whilst  the  assessment  made  cannot  be  sustained,  we 
think  that  the  relator  ought  not  to  escape  a  proper  assess- 
ment for  the  propert}^  It  is  true  that  the  commissioners 
are  not  free  to  capriciously  disregard  the  evidence  and 
emancipate  themselves  from  all  restrictions  and  rules, 
however  fundamental;  they  are  not  bound  by  statements 
that  are  contradicted  and  which  they  disbelieve,  where 
good  reasons  exist  for  such  disbelief.  (The  People  ex  rel. 
Union  Trust  Co.  v.  Coleman,  supra;  The  People  ex  rel. 
Edison  El.  Co.  v.  Barker,  139  N.  Y.  55-67;  The  People  ex 
rel.  Manh.  F.  Ins.  Co.  v.  The  Comrs.  of  Taxes,  76  id.  64; 
The  People  ex  rel.  Gen.  El.  Co.  v.  Barker,  141  id.  251;  Peo- 
ple ex  rel.  Westchester  F.  Ins.  Co.  v.  Davenport,  91  id. 
574.)  The  letter  of  Mr.  Davies  in  1893  to  the  effect  that 
if  the  assessment  was  made  at  $12,500,000  the  company 
would  acquiesce,  having  been  written  for  the  purpose  of 
a  settlement,  and  an  adjustment  of  the  controversy  then 
existing,  could  not  properly  be  adopted  by  the  commis- 
sioners as  the  basis  of  an  assessment  for  subsequent  years. 
Still,  at  the  same  time,  it  might  well  create  a  suspicion  as 
"to  the  truthfulness  of  a  statement  made  the  year  follow- 
ing showing  that  so  far  as  the  property  of  the  corporation 
was  concerned,  aside  from  its  franchises,  it  was  insolvent 
to  the  extent  of  $3,000,000.  Aside  from  this,  there  exists 
the  fact  that  the  net  earnings  of  the  corporation  for  the 
year  were  such  as  to  enable  it  to  pay  the  interest  upon  its 
indebtedness  and  a  dividend  upon  its  thirty  millions  of 
capital  stock  of  6  per  cent  and  still  have  a  surplus  bor- 
dering upon  a  million  dollars.    These  facts  fully  justified 


SOME  JUDICIAL  DECISIONS  435 

the  commissioners  in  discrediting  the  statement  made  to 
them  by  the  relator.  Personal  property,  unlike  real  prop- 
erty, may  not  always  be  readily  found  and  assessments 
thereof  by  assessors  are  often  attended  with  difficulties. 
For  these  reasons  more  latitude  necessarily  should  be  giv- 
en assessors  in  ascertaining  and  determining  the  amount 
and  value  of  personal  property.  Presumptions  to  some 
extent  should  be  indulged.  For  this  reason  the  earnings 
of  a  corporation  may  be  considered  by  the  assessors,  and 
where  they  are  such  as  to  enable  the  company  to  pay  its 
running  expenses,  necessary  repairs,  interest  upon  its  in- 
debtedness and  declare  a  dividend  of  6  per  cent  and  still 
have  a  surplus,  it  may  be  assured  that  its  capital  stock  re- 
mains unimpaired  and  that  there  are  assets  over  and 
above  sufficient  to  pay  for  its  outstanding  indebtedness. 
(People  ex  rel.  The  Equitable  Gas  Light  Co.  v.  Barker, 
144N.  Y.  91). 

This  method,  however,  may  include  the  value  of  the 
franchises  which  should  be  deducted  in  order  to  determine 
the  amount  of  property  liable  for  assessment.  Such  value 
has  not  been  given  and  we  are  consequently  left  without  the 
evidence  at  hand  upon  which  to  determine  the  actual  value 
of  the  personal  property  under  the  presumptions  arising 
from  the  facts  mentioned.  It  may  turn  out  that  the  cap- 
ital stock  represents  property  to  the  amount  thereof  in 
addition  to  the  franchises;  that  the  stock  issued  to  the 
stockholders  of  the  New  York,  Metropolitan  and  Subur- 
ban companies  represented  money  actually  paid  by  the 
stockholders  of  those  companies  for  real  estate  and  the 
building  construction  and  equipments  of  the  elevated  rail- 
roads thereon.  Should  such  be  the  case,  the  presumption 
from  the  earnings  of  the  company  w^ould  be  permissible, 
that  the  capital  stock  remained  unimi^aired,  representing 
property  over  and  above  the  franchises,  to  the  amount 
thereof,  and  in  addition,  sufficient  to  pay  the  outstanding 
indebtedness.     Upon  this   basis  the  assessable  personal 


436  SOME  JUDICIAL  DECISIONS 

property  could  be  determined  by  adding  to  the  capital 
stock  issued  the  surplus  still  of  hand  not  invested  in  the 
real  and  personal  property  of  the  company  and  deduct- 
ing therefrom  the  assessable  value  of  the  real  estate,  the 
stock  in  other  companies  and  the  10  per  cent  allowed  by 
statute.    The  result  would  be  as  follows : 

Capital    stock    $29,925,200 

Surplus  on  hand  in  cash  1,382,838 

Total     $31,308,038 

Real   estate    ., $7,323,200 

Stock  in  other  companies   . . .' 7.075,200 

Ten  per  cent  of  capital    2,992,520 

17,390,920 

Amount  assessable   $13,917,118 


The  General  Term  was  of  the  opinion  that  this  assess- 
ment could  be  sustained  upon  the  authority  of  The  People 
ex  rel.  The  Equitable  Gas  Light  Co.  v.  Barker  (144  N.  Y. 
94).  The  difficulty  is  that  in  that  case  the  value  of  the 
patents  and  franchise  was  found  to  be  $500,000,  whilst  in 
this  case  we  have  no  value  given  to  the  franchises  or  facts 
appearing  from  which  such  value  can  be  determined. 

The  statute  provides  that  upon  the  return  of  a  writ  of 
certiorari  to  review  an  assessment  the  court  shall  have 
power  to  order  the  assessment,  if  illegal,  to  be  stricken 
from  the  roll,  or,  if  erroneous  or  unequal,  to  order  a  re- 
assessment of  the  property,  etc.  (laws  of  1880,  chap.  269,  4). 
The  assessment  in  this  case  is  not  illegal;  it  is  merely  er- 
roneous.   A  re-assessment  should,  therefore,  be  ordered. 

The  order  of  the  General  Term  should  be  reversed  and 
that  of  the  Special  Term  modified  so  as  to  vacate  the  as- 
sessment made  and  order  a  re-assessment  by  the  commis- 
sioners, without  costs  of  this  appeal  to  either  party. 

All  concur,  except  O'BEIEN,  J.  not  voting. 

Ordered  accordingly. 


CITY  OF  KNOXVILLE  V.  KNOXVILLE  WATER  CO. 

U.  S.  REPORTS  212  2--19 

[Mr.  Justice  Moody  delivered  the  opinion  of  the  court.] 

This  is  an  appeal  by  the  city  of  Knoxville  from  a  de- 
cree of  the  Circuit  Court  of  the  United  States  for  the 
Eastern  District  of  Tennessee.  The  appellee  is  a  public 
service  corporation,  chartered  for,  and  engaged  in,  the 
business  of  supplying  that  city  and  its  inhabitants  with 
water  for  domestic  and  other  uses.  The  cause  in  which 
the  decree  was  rendered  is  a  suit  in  equity  which  was 
brought  by  the  company  on  December  7,  1901,  against  the 
city  to  restrain  the  enforcement  of  a  city  ordinance  fixing 
in  detail  the  maximum  rates  to  be  charged  by  the  com- 
pany. This  ordinance  was  enacted  on  March  30, 1901.  The 
bill  contained  may  allegations,  which  have  become  imma- 
terial by  ithe  decision  of  this  court  in  Knoxville  Water 
Company  v.  Knoxville,  189  U.  S.  434,  in  which  the  valid- 
ity of  the  ordinance  was  sustained,  except  so  far  as  it  might 
confiscate  the  property  of  the  company  by  fixing  rates  so 
low  as  to  have  that  effect.  The  latter  contention  alone  was 
left  open  to  the  company,  and  to  it  the  remainder  of  the 
bill  is  mainly  directed.  The  allegations  in  that  regard  are, 
that  the  rates  fixed  by  the  ordinance  w^ere  so  low  that  they 
denied  to  the  company  a  reasonable  return  upon  the  prop- 
erty employed  in  the  business,  and  thereby  took  it  for  pub- 
lic use  without  comipensation,  in  violation  of  the  Four- 
teenth Amendment  to  the  Constitution  of  the  United 
States.  After  answer  by  the  respondent  and  replication 
by  the  complainant  the  cause  was  referred  to  a  special 
master,  whose  report  was  confirmed  by  the  court.  The 
master  found  and  reported  that  the  value  of  the  plant  and 

437 


438  SOME  JUDICIAL  DECISIONS 

property  employed  in  tlie  business  at  the  date  of  the  pass- 
age of  the  ordinance  was  $608,427.95;  that  the  gross  in- 
come from  the  company's  business  was  $88,481.39,  and 
that  the  operating  expenses  were  $34,750.91.  The  figures 
of  income  and  expense  are  those  of  the  fiscal  j^ear  ending 
March  31,  1901,  and  the  valuation  was  made  as  of  that 
date.  The  master  found  and  reported  that  the  diminution 
of  income  which  would  have  resulted  from  the  enforce- 
ment of  the  ordinance  during  that  fiscal  year  was  $17,- 
623.64,  and  that  the  gross  income  would  have  been  reduced 
thereby  to  $70,857.75,  leaving  a  net  income  of  $36,106.84. 
This  net  income  was  less  than  6  per  cent  on  the  valuation. 
In  the  oj)inion  of  the  master  8  per  cent,  which  included  2 
per  cent  to  provide  for  depreciation,  was  the  minimum  net 
return  which  the  company  was  entitled  to  earn.  The 
judge  of  the  Circuit  Court,  in  his  opinion  confirming  the 
master's  report,  adopted  the  master's  valuation  of  the 
whole  plant  and  property  at  $608,427.95  (although  he  held 
that  it  ought  to  be  increased  by  about  $3,000.00),  and  the 
master's  finding  that  the  gross  income  was  $88,481.39;  that 
the  expenses  were  $34,750,91;  that  the  effect  of  the  re- 
duction made  by  the  ordinance  would  be  to  lessen  the 
gross  income  by  $17,623.64,  and  that  therefore  the  net  in- 
come under  the  ordinance  would  be  $36,106.84,  or  about 
$400.00,  less  than  6  per  cent  on  the  valuation.  Upon  these 
assumptions  of  fact  as  to  its  effect  the  judge  regarded  the 
ordinance  as  confiscatory  and  issued  a  permanent  injunc- 
tion against  its  enforcement. 

At  the  threshold  of  the  consideration  of  the  case  the 
attitude  of  this  court  to  the  facts  found  below  should  be 
defined.  Here  are  findings  of  fact  by  a  master,  confirmed 
by  the  court.  The  company  contends  that  under  these  cir- 
cumstances the  findings  are  conclusive  in  this  court,  un- 
less they  are  without  support  in  the  evidence  or  were  made 
under  the  influence  of  erroneous  views  of  law.  We  need 
not  stop  to  consider  what  the  effect  of  such  findings  would 


SOME  JUDICIAL  DECISIONS  439 

be  in  an  ordinary  suit  in  equity.  The  purpose  of  this  suit 
is  to  arrest  the  operation  of  a  law  on  the  ground  that  it  is 
void  and  of  no  effect.  It  happens  that  in  this  particular 
case  it  is  not  an  act  of  the  legislature  that  is  attacked,  but 
an  ordinance  of  a  municipality.  Nevertheless  the  func- 
tion of  rate-making  is  purely  legislative  in  its  character, 
and  this  is  true,  whether  it  is  exercised  directly  by  the  leg- 
islature itself  or  by  some  subordinate  or  administrative 
body,  to  whom  the  power  of  fixing  rates  in  detail  has  been 
delegated.  The  completed  act  derives  its  authority  from 
the  legislature  and  must  be  regarded  as  an  exercise  of  the 
legislative  power.  (Prentis  v.  Southern  Railway  Co.,  211 
U.  S.  210;  Honolulu  Transit  Co.  v.  Hawaii,  211  U.  S.  282.) 
There  can  be  at  this  day  no  doubt,  on  the  one  hand,  that 
the  courts  on  constitutional  grounds  may  exercise  the 
power  of  refusing  to  enforce  legislation,  nor,  on  the  other 
hand,  that  that  power  ought  to  be  exercised  only  in  the 
clearest  cases.  The  constitutional  invalidity  should  be 
manifest,  and  where  that  invalidity  rests  upon  disputed 
questions  of  fact  the  invalidating  facts  must  be  proved  to 
the  satisfaction  of  the  court.  In  view  of  the  character  of 
the  judicial  power  invoked  in  such  cases  it  is  not  tolerable 
that  its  exercise  should  rest  securely  upon  the  findings  of 
a  master,  even  though  they  be  confirmed  by  the  trial  court. 
The  power  is  best  safeguarded  against  abuse  by  preserv-- 
ing  to  this  court  complete  freedom  in  dealing  with  the 
facts  of  each  case.  Nothing  less  than  this  is  demanded  by 
the  respect  due  from  the  judicial  to  the  legislative  author- 
ity. It  must  not  be  understood  that  the  findings  of  a  mast- 
er, confirmed  by  the  trial  court,  are  without  weight,  or 
that  they  will  not,  as  a  practical  question  sometimes  be 
regarded  as  conclusive.  All  that  is  intended  to  be  said  is, 
that  in  cases  of  this  character  this  court  will  not  fetter  its 
discretion  or  judgment  by  any  artificial  rules  as  to  the 
weight  of  the  master's  findings,  however  useful  and  well- 


440  SOME  JUDICIAL  DECISIONS 

settled  these  rules  may  be  in  ordinary  litigation.    We  ap- 
proach the  discussion  of  the  facts  in  this  spirit. 

The  first  fact  essential  to  the  conclusion  of  the  court 
below  is  the  valuation  of  the  property  devoted  to  the  pub- 
lic uses,  upon  which  the  company  is  entitled  to  earn  a  re- 
turn. That  valuation  ($608,000)  must  now  be  considered. 
It  was  made  up  by  adding  to  the  appraisement,  in  minute 
detail  of  all  the  tangible  property,  the  sum  of  $10,000  for 
'^organization,  promotion,  etc.,"  and  $60,000  for  ''going 
concern."  The  latter  sum  we  understand  to  be  an  expres- 
sion of  the  added  value  of  the  plant  as  a  whole  over  the 
sum  of  the  values  of  its  component  parts,  which  is  at- 
tached to  it  because  it  is  in  active  and  successful  opera- 
tion, and  earning  a  return.  We  express  no  opinion  as  to 
the  propriety  of  including  these  two  items  in  the  valuation 
of  the  plant,  for  the  purpose  for  which  it  is  valued  in  this 
case,  but  leave  that  question  to  be  considered  when  it  nec- 
essarily arises.  We  assume,  without  deciding,  that  these 
items  were  properly  added  in  this  case.  The  value  of  the 
tangible  property  found  by  the  master  is,  of  course,  $608,- 
000  lessened  by  $70,000,  the  value  attributed  to  the  in- 
tangible property,  making  $538,000.  This  valuation  was 
determined  by  the  master  by  ascertaining  what  it  would 
cost,  at  the  date  of  the  ordinance,  to  reproduce  the  exist- 
ing plant  as  a  new  plant.  The  cost  of  reproduction  is  one 
way  of  ascertaining  the  present  value  of  a  plant  like  that 
of  a  water  company,  but  that  test  would  lead  to  obviously 
incorrect  results,  if  the  cost  of  reproduction  is  not  dimin- 
ished by  the  depreciation  which  has  come  from  age  and 
use.  The  company  contends  that  the  master,  in  fixing  up- 
on the  valuation  of  the  tangible  property,  did  make  an 
allowance  for  depreciation,  but  we  are  unable  to  agree  to 
this.  The  master  nowhere  says  that  he  made  allowance 
for  depreciation  and  the  language  of  his  report  is  incon- 
sistent with  such  a  reduction.  The  figures  which  he 
adopts  are  those  of  a  ''fair  contractor's  price."    The  basis 


SOME  JUDICIAL  DECISIONS  441 

of  his  calculation  was  tlie  testimony  of  an  opinion  witness 
called  by  the  company.  That  witness  submitted  a  table, 
which  avowedly  showed  the  cost  of  reproduction  without 
allowance  for  depreciation.  The  values  testified  to  by  him 
were  adopted  by  the  master  in  the  great  majority  of  cases. 
The  witness'  valuation  of  the  tangible  property  was 
somewhat  reduced  by  the  master,  but  the  reductions  were 
not  based  upon  the  theory  of  depreciation,  but  upon  a  dif- 
ference of  opinion  as  to  the  reproduction  cost. 

The  cost  of  reproduction  is  not  always  a  fair  measure 
of  the  present  value  of  a  plant  which  has  been  in  use  for 
many  years.  The  items  composing  the  plant  depreciate 
in  value  from  year  to  year  in  a  varying  degree.  Some 
pieces  of  property,  like  real  estate  for  instance,  depreciate 
not  at  all,  and  sometimes,  on  the  other  hand,  appreciate 
in  value.  But  the  reservoirs,  the  mains,  the  service  pipes, 
structures  upon  real  estate,  standpipes,  pumps,  boilers, 
meters,  tools  and  appliances  of  every  kind  begin  to  depre- 
ciate with  more  or  less  rapidity  from  the  moment  of  their 
first  use.  It  is  not  easy  to  fix  at  any  given  time  the  amount 
of  depreciation  of  a  plant  whose  component  parts  are  of 
different  ages  with  different  expectations  of  life.  But  it 
is  clear  that  some  substantial  allowance  for  depreciation 
ought  to  have  been  made  in  this  case.  The  officers  of  the 
company,  alio  intuitu,  estimated  what  they  called^ 'incom- 
plete depreciation"  of  this  plant  (which  we  understand  to 
be  the  depreciation  of  the  surviving  parts  of  it  still  in  use) 
at  $77,000,  which  is  14  per  cent  of  the  master's  apprais- 
ment  of  the  tangible  property.  A  witness  called  by  the 
city  placed  the  reproduction  value  of  the  tangible  prop- 
erty at  $363,000,  and  estimated  the  allowance  that  should 
be  made  for  depreciation  at  $118,000,  or  32  per  cent.  In 
the  view  we  take  of  the  case  it  is  not  necessary  that  we 
should  undertake  the  difficult  task  of  determining  exactly 
how  much  the  master's  valuation  of  the  tangible  property 
ought  to  have  been  diminished  by  the  depreciation  which 


442  SOME  JUDICIAL  DECISIONS 

that  property  had  undergone.  It  is  enough  to  say  that 
there  should  have  been  a  considerable  diminution,  suffi- 
cient at  least  to  raise  the  net  income  found  by  the  court 
above  6  per  cent  upon  the  whole  valuation  thus  dimin- 
ished. If,  for  instance,  the  master's  valuation  should  be 
diminished  by  $50,000,  allowed  for  depreciation,  the  net 
earnings  found  by  him  would  show  a  return  of  substanti- 
ally 6.5  per  cent. 

Counsel  for  the  company  urge  rather  faintly  that  the 
capitalization  of  the  company  ought  to  have  some  influ- 
ence in  the  case  in  determining  the  valuation  of  the  prop- 
erty. It  is  a  sufficient  answer  to  this  contention  that  the 
capitalization  is  shown  to  be  considerably  in  excess  of 
any  valuation  testified  to  by  any  witness,  or  which  can  be 
arrived  at  by  any  process  of  reasoning.  The  cause  for  the 
large  variation  between  the  real  value  of  the  property  and 
the  capitalization  in  bonds  and  preferred  and  common 
stock  is  apparent  from  the  testimony.  All,  or  substan- 
tially all,  the  preferred  and  common  stock  was  issued  to 
contractors  for  the  construction  of  the  plant,  and  the  nom- 
inal amount  of  the  stock  issued  was  greatly  in  excess  of 
the  true  value  of  the  property  furnished  by  the  contracts. 
A  single  instance  taken  from  the  testimony  will  illustrate 
this.  At  the  very  start  of  the  enterprise  a  contract  was 
entered  into  for  the  construction  of  a  part  of  the  plant, 
which  was  of  a  value  slightly,  if  at  all,  exceeding  $125,- 
000.  The  price  paid  the  contractor  was  $125,000  in  bonds 
and  $200,000  in  common  stock.  Other  contracts  for  con- 
struction showed  a  like  disproportion  between  value  furn- 
ished and  nominal  capitalization  received  for  that  value. 
It  perhaps  is  unnecessary  to  say  that  such  contracts  were 
made  by  the  company  with  persons  who,  at  the  time,  by 
stock  ownership,  controlled  its  action.  Bonds  and  pre- 
ferred and  common  stock  issued  under  such  conditions 
afford  neither  measure  of  nor  guide  to  the  value  of  the 
property. 


SOME  JUDICIAL  DECISIONS  443 

We  think  that  the  master  and  the  court  erred  in  an- 
other respect,  which  might  affect  in  an  important  way  the 
amount  which  could  have  been  realized  under  the  opera- 
tion of  the  ordinance.  This  error  consisted  in  the  manner 
of  deducting  the  reductions  necessarily  made  by  the  or- 
dinance. The  evidence  in  the  record  is  not  entirely  clear, 
though,  after  careful  consideration,  we  think  it  shows  the 
following  state  of  facts:  The  company's  schedule  pre- 
scribed certain  rates,  which  we  may  call  the  book  rates, 
but  upon  a  large  part  of  them  a  discount  of  5  per  cent  was 
made  if  they  were  promptly  paid.  The  consumers  very 
generally  availed  themselves  of  this  discount.  The  dis- 
count rates  constituted  the  actual  collections,  and  may  be 
called  the  actual  rates.  For  the  fiscal  year  which  was  ex- 
amined the  book  rates  amounted,  in  round  numbers,  to 
$93,000,  while  the  actual  rates  amounted,  as  the  master 
found,  to  $88,000.  The  percentage  of  reduction  made  by 
the  ordinance  was  computed  to  be  22.88.  This  percentage 
was  ascertained  either  by  comparing  the  book  rates  with 
the  ordinance  rates,  or  by  comparing  the  actual  rates  with 
the  ordinance  rates,  still  further  reduced  by  a  5  per  cent 
discount  for  prompt  payment,  which  comes  to  substan- 
tially the  same  result.  The  fallacy  in  the  process  em- 
ployed by  the  master  consisted  in  substance  in  assuming 
that  the  ordinance  rates  would  be  subject  to  a  discount  for 
prompt  payment.  The  company,  it  is  true,  might,  if  it 
chose,  allow  such  a  discount  from  the  ordinance  rates,  but 
the  ordinance  required  no  discount  from  the  rates  estab- 
lished by  it,  and  the  company  therefore  was  bound  to  offer 
none.  11  it  stood  upon  the  letter  of  the  ordinance,  as  it  had 
the  right  to  do,  and  exacted  from  the  consumers  the  full 
charges  prescribed  by  the  ordinance,  the  amount  which 
would  have  been  realized  would  have  been  over  $4,000 
more  than  that  found  by  the  master,  or  a  net  income  of  not 
less  than  $40,000.  Doubtless,  the  abandonment  of  the  com- 
mon method  of  discount  for  prompt  payment  would  de- 


444  SOME  JUDICIAL  DECISIONS 

prive  the  company  of  an  efficient  aid  to  the  quick  collec- 
tion of  its  bUIs,  but  in  the  case  of  a  prime  necessity  like 
water  there  are  other  methods  of  enforcing  prompt  pay- 
ment, though  it  is  not  unlikely  that  the  elimination  of  the 
discount  rate  would  add  somewhat  to  the  cost  of  collec- 
tion and  thereby  to  the  operating  expenses. 

A  brief  recently  filed  by  the  city,  to  which  no  reply  has 
been  made,  seems  to  show  conclusively  that  there  was  still 
another  error  in  ascertaining  the  amount  of  reduction  ef- 
fected by  the  ordinance.  What  was  actually  done  was  to 
deduct  the  22.88  reduction  from  the  actual  water  rates 
(excluding  hydrant  rentals,  which  were  not  changed),  but 
of  these  actual  water  rates  $10,000  came  from  territory 
outside  of  the  corporate  limits,  which  was  not  affected  by 
the  ordinance.  From  this  $10,000  no  percentage  should 
have  been  deducted.  The  reduction  therefore,  was  too 
large  by  over  $2,000.  If  this  correction  should  be  made,  it 
would  amount  to  nearly  four-tenths  of  one  per  cent  on  the 
capitalization. 

We  are  also  of  opinion  that  the  master  and  the  court 
erroneously  excluded  evidence  which  had  an  important 
bearing  upon  the  true  earning  capacity  of  the  company 
under  the  ordinance.  A  clear  appreciation  of  this  error 
can  be  best  obtained  by  a  comprehensive  review  of  the 
hearing.  The  company's  original  case  was  based  upon  an 
elaborate  analysis  of  the  cost  of  construction.  To  arrive 
at  the  present  value  of  the  plant  large  deductions  were 
made  on  account  of  the  depreciation.  This  depreciation 
was  divided  into  complete  depreciation  and  incomplete  de- 
preciation. The  complete  depreciation  represented  that 
part  of  the  original  plant  which  through  destruction  or 
obsolescence  had  actually  perished  as  useful  property.  The 
incomplete  depreciation  represented  the  impairment  in 
value  of  the  parts  of  the  plant  which  remained  in  exist- 
ence and  were  continued  in  use.  It  was  urgently  contend- 
ed that  in  fixing  upon  the  value  of  the  plant  upon  which 


SOME  JUDICIAL  DECISIONS  445 

tlie  company  was  entitled  to  earn  a  reasonable  return  the 
amounts  of  complete  and  incomplete  depreciation  should 
be  added  to  the  present  value  of  the  surviving  parts.  The 
court  refused  to  approve  this  method,  and  we  think  prop- 
erly refused.  A  water  plant,  with  all  its  additions,  begins 
to  depreciate  in  value  from  the  moment  of  its  use.  Before 
coming  to  the  question  of  profit  at  all  the  company  is  en- 
titled to  earn  a  sufficient  sum  annually  to  provide  not  only 
for  current  repairs  but  for  making  good  the  depreciation 
and  replacing  the  parts  of  the  property  when  they  come  to 
the  end  of  their  life.  The  company  is  not  bound  to  see  its 
property  gradually  waste,  without  making  provision  out 
of  earnings  for  its  replacement.  It  is  entitled  to  see  that 
from  earnings  the  value  of  the  property  invested  is  kept 
unimpaired,  so  that  at  the  end  of  any  given  term  of  years 
the  original  investment  remains  as  it  was  at  the  begin- 
ning. It  is  not  only  the  right  of  the  company  to  make 
such  a  provision,  but  it  is  its  duty  to  its  bond  and  stock- 
holders, and,  in  the  case  of  a  public  service  corporation  at 
least,  its  plain  duty  to  the  public.  If  a  different  course 
were  pursued  the  only  method  of  providing  for  replace- 
ment of  property  which  has  ceased  to  be  useful  would  be 
the  investment  of  new  capital  and  the  issue  of  new  bonds 
or  stocks.  This  course  would  lead  to  a  constantly  increas- 
ing variance  between  present  value  and  bond  and  stock 
capitalization — a  tendency  which  would  inevitably  lead  to 
disaster  either  to  the  stockholders  or  to  the  public,  or  both. 
If,  however,  a  company  fails  to  perform  this  plain  duty 
and  to  exact  sufficient  returns  to  keep  the  investment  un- 
impaired, whether  this  is  the  result  of  unwarranted  divi- 
dends upon  over-issues  of  securities,  or  of  omission  to  ex- 
act proper  prices  for  the  output,  the  fault  is  its  o^ti. 
When,  therefore,  a  public  regulation  of  its  prices  comes 
under  question  the  true  value  of  the  property  then  em- 
ployed for  the  purpose  of  earning  a  return  cannot  be 


446  SOME  JUDICIAL  DECISIONS 

enhanced  by  a  consideration  of  the  errors  in  management 
which  have  been  committed  in  the  past. 

After  the  company  had  closed  its  case  the  city  imder- 
took  to  determine  the  present  value  of  the  company's 
property  by  the  plain  method  of  ascertaining  the  cost  of 
reproduction,  diminished  by  depreciation.  In  its  case  in 
rebuttal,  the  company  followed  the  same  method,  though 
the  results  differed  largely,  and,  as  we  have  seen,  no  prop- 
er allowance  for  depreciation  was  made.  In  the  course  of 
presenting  its  case  the  city  offered  evidence  of  the  net  in- 
come of  some  years  subsequent  to  the  passage  of  the  ordin- 
ance. The  case  is  peculiar.  The  company  has  never  ob- 
served the  ordinance.  The  suit  was  begun  nine  months 
after  its  enactment  and  tried  considerably  later.  In  the 
meantime  the  company's  gross  income  had  largely  in- 
creased. But  the  decision  in  the  court  below  Was  based 
solely  on  the  operations  of  the  fiscal  year  ending  March  31, 
1901,  and  the  amount  of  net  income  ascertained,  namely, 
$36,000,  was  obtained  by  applying  the  reductions  made  by 
the  ordinance  to  the  operations  of  that  fiscal  year.  We 
think  it  was  an  error  to  confine  the  investigation  to,  and 
base  the  judgment  upon,  that  year  alone.  The  precise 
subject  of  inquiry  was,  what  would  be  the  effect  of  the 
ordinance  in  the  future.  The  operations  of  the  preceding 
fiscal  year,  or  of  any  other  past  fiscal  year,  were  valueless 
if  the  year  was  abnormal,  and  were  only  of  significance  so 
far  as  they  foretold  the  future.  If,  as  in  this  case,  suffi- 
cient time  has  passed,  so  that  certainty  instead  of 
prophecy  can  be  obtained,  the  certainty  would  be  prefer- 
able to  the  prophecy.  In  this  case  there  could  be  no  abso- 
lute certainty,  because  the  ordinance  had  never  been  put 
in  operation.  But  evidence  of  the  operations  of  the  years 
succeeding  to  the  ordinance  is  relevant  and  of  great  im- 
portance, and  by  a  consideration  of  such  evidence  a  much 
greater  degree  of  certainty  could  be  obtained.  Suppose, 
by  way  of  illustration,  that  before  bringing  suit  the  com- 


SOME  JUDICIAL  DECISIONS  447 

pany  had  put  the  ordinance  into  effect  and  had  observed 
it  for  a  number  of  years,  and  the  result  showed  that  a  suffi- 
cient net  income  had  been  realized,  is  it  possible  that  a 
suit  then  could  be  brought  and  the  evidence  confined  to  a 
period  prior  to  the  ordinance,  and  by  a  process  o£  specu- 
lation the  conclusion  reached  that  the  ordinance  would  be 
confiscatory?  Some  evidence  regarding  the  income  of  the 
company,  after  the  passage  of  the  ordinance,  is  in  the  rec- 
ord, but  it  subsequently  was  excluded  from  consideration. 
It  showed  an  increase  of  gross  and  net  earnings,  but  also 
an  increase  in  the  property  devoted  to  the  public  use.  We 
are  unable  to  say  what  the  effect  of  the  evidence  excluded 
would  be;  all  we  can  say  is,  that  the  inquiry  was  undul}' 
limited  by  the  exclusion  of  the  evidence  of  the  operation  of 
subsequent  years. 

It  follows  from  what  has  been  said  that  the  judgment 
of  the  court  below  cannot  stand.  There  was  error  in  the 
appraisement  of  the  present  value  of  the  plant,  in  the  de- 
duction of  the  reductions  made  by  the  ordinance,  and  in 
the  exclusion  of  evidence  relating  to  the  operations  of  the 
company  after  the  enactment  of  the  ordinance. 

If  hereafter  it  shall  appear,  under  the  actual  operation 
of  the  ordinance,  that  the  returns  allowed  by  it  operate  as 
a  confiscation  of  property,  nothing  in  this  judgment  will 
prevent  another  application  to  the  courts  of  the  United 
States  or  to  the  courts  of  the  State  of  Tennessee.  But  as 
the  case  now  stands  there  is  no  such  certainty  that  the 
rates  prescribed  will  necessarily  have  the  effect  of  deny- 
ing to  the  company  such  a  return  as  would  avoid  confis- 
cation.   For  these  reasons — 

The  decree  is  reversed  and  the  case  remanded  to  the 
court  below  with  directions  to  dismiss  the  bill  without 
prejudice. 


WILCOXET  AL.  V.  CONSOLIDATED    GAS  CO. 

U.  S.  REPORTS  212  19-55 

[Mr.  Justice  Peckham  delivered  the  opinion  of  the  court.] 

At  the  outset  it  seems  to  us  proper  to  notice  the  views 
regarding  the  action  of  the  court  below,  which  have  been 
stated  by  counsel  for  the  appellants,  the  Public  Service 
Commission,  in  their  brief  in  this  court.  They  assume  to 
criticise  that  court  for  taking  jurisdiction  of  this  case,  as 
precipitate,  as  if  it  were  a  question  of  discretion  or  comity, 
whether  or  not  that  court  should  have  heard  the  case.  On 
the  contrary,  there  was  no  discretion  or  comity  about  it. 
When  a  federal  court  is  properly  appealed  to  in  a  case 
over  which  it  has  by  law  jurisdiction  it  is  the  duty  to  take 
jurisdiction  (Cohens  v.  Virginia,  6  Wheat.  264,  404),  and 
in  taking  it  that  court  cannot  be  truthfully  spoken  of  as 
precipitate  in  its  conduct.  That  the  case  may  be  one  of 
local  interest  only  is  entirely  immaterial,  so  long  as  the 
parties  are  citizens  of  different  states  or  a  question  is  in- 
volved which  by  law  brings  the  case  within  the  jurisdic- 
tion of  a  federal  court.  The  right  of  a  party  plaintiff  to 
choose  a  federal  court  where  there  is  a  choice  cannot  be 
properly  denied.  In  re  Metropolitan  Railway  Receiver- 
ship, 208  U.  S.  90-110 ;  Prentis  v.  Atlantic  Coast  Line  et  al., 
211  U.  S.  210.  In  the  latter  case  it  was  said  that  a  plaintiff 
could  not  be  forbidden  to  try  the  facts  upon  which  his 
right  to  relief  is  based  before  a  court  of  his  own  choice,  if 
otherwise  competent.  It  is  true  an  application  for  an  in- 
junction was  denied  in  that  case  because  the  plaintiff  should 
in  our  opinion  have  taken  the  appeal  allowed  him  by  the  law 
of  Virginia  while  the  rate  of  fare  in  litigation  was  still  at 
the  legislative  stage,  so  as  to  make  it  absolutely  certain 

448 


SOME  JUDICIAL  DECISIONS  449 

that  the  officials  of  the  state  would  try  to  establish  and 
enforce  an  unconstitutional  rule. 

The  case  before  us  is  not  like  that.  It  involves  the  con- 
stitutionality, with  reference  to  the  Federal  Constitution, 
of  two  acts  of  the  legislature  of  New  York,  and  it  is  one 
over  which  the  Circuit  Court  undoubtedly  had  jurisdic- 
tion under  the  act  of  Congress,  and  its  action  in  taking 
and  hearing  the  case  cannot  be  the  subject  of  proper  crit- 
icism. ' 

An  examination  of  the  record  herein,  with  reference  to 
the  questions  involved  in  the  merits,  shows  that  the  act 
imder  which  the  Gas  Commission  was  appointed  was  sub- 
sequently to  the  commencement  and  trial  of  this  suit,  de- 
clared, on  grounds  not  here  material,  to  be  unconstitution- 
al by  the  Court  of  Appeals  of  New  York.  (191  N.  Y.  123, 
February  18,  1908.)  The  order  made  by  the  commission 
must  therefore  be  regarded  as  invalid.  It  is  not  important 
in  this  case,  because  the  act  of  the  legislature  of  1906, 
makes  the  same  provision  as  to  the  price  of  gas  to  consum- 
ers other  than  the  city  that  the  order  does.  We  have  as 
remaining  to  be  considered  the  above-mentioned  two  acts 
of  the  legislature. 

The  question  arising  is  as  to  the  validity  of  the  acts 
limiting  the  rates  for  gas  to  the  prices  therein  stated.  The 
rule  by  which  to  determine  the  question  is  pretty  well 
established  in  this  court.  The  rates  must  be  plainly  un- 
reasonable to  the  extent  that  their  enforcement  would  be 
equivalent  to  the  taking  of  property  for  public  use  without 
such  compensation  as  under  the  circumstances  is  just  both 
to  the  owner  and  the  public.  There  must  be  a  fair  return 
upon  the  reasonable  value  of  the  property  at  the  time  it  is 
being  used  for  the  public.  (San  Diego  Land  &  Town  Com- 
pany V.  National  City,  174  U.  S.  739,  757;  Same  v.  Jasper, 
189  U.  S.  439,  442.  J 

Many  of  the  cases  are  cited  in  Knoxville  v.  Water  Co., 
Just  decided,  ante,  p.  1.    The  case  must  be  a  clear  one  be- 

B— VIII— 29 


450  SOME  JUDICIAL  DECISIONS 

fore  the  courts  ought  to  be  asked  to  interfere  with  state 
legislation  upon  the  subject  of  rates,  especially  before 
there  has  been  any  actual  experience  of  the  practical  re- 
sult of  such  rates.  In  this  case  the  rates  have  not  been  en- 
forced as  yet,  because  the  bill  herein  was  filed  and  an  in- 
junction  obtained  restraining  their  enforcement  before 
they  came  into  actual  operation. 

In  order  to  detemiine  the  rate  of  return  upon  the  rea- 
sonable value  of  the  property  at  the  time  it  is  being  used 
for  the  public,  it,  of  course,  becomes  necessary  to  ascer- 
tain what  that  value  is.  A  very  great  amount  of  evidence 
was  taken  before  the  master  upon  that  subject,  which  is 
included  in  five  large  volumes  of  the  record.  Valuations 
by  expert  witnesses  were  given  as  to  the  value  of  the  real 
estate  OT\Tied  by  the  complainant,  and  as  to  the  value  of 
the  mains,  service  pipes,  plants,  meters  and  miscellaneous 
personal  jDroperty. 

The  value  of  real  estate  and  plant  is  to  a  considerable 
extent  matter  of  opinion,  and  the  same  may  be  said  of  per- 
sonal estate  when  not  based  upon  the  actual  cost  of  ma- 
terial and  construction.  Deterioration  of  the  valu§  of  the 
plant,  mains,  and  pipes  is  also  to  some  extent  based  upon 
opinion.  All  these  matters  make  questions  of  value  some- 
what uncertain;  while  added  to  this  is  an  alleged  prospec- 
tive loss  of  income  from  a  reduced  rate,  a  matter  also  of 
much  uncertainty,  depending  upon  the  extent  of  the  re- 
duction and  the  probable  increased  consumption,  and  we 
have  a  problem  as  to  the  character  of  a  rate  which  is  diffi- 
cult to  answer  without  a  practical  test  from  actual  oper- 
ation of  the  rate.  Of  course,  there  may  be  cases  where 
the  rate  is  so  low  upon  any  reasonable  bases  of  valuation 
that  there  can  be  no  just  doubt  as  to  its  confiscatory  na- 
ture, and  in  that  event  there  should  be  no  hesitation  in 
so  deciding  and  in  enjoining  its  enforcement  without  wait- 
ing for  the  damage  which  must  inevitably  accompany  the 
operation  of  the  business  under  the  objectionable  rate.    But 


SOME  JUDICIAL  DECISIONS  451 

where  the  rate  complained  of  shows  in  any  event  a  very 
narrow  line  of  division  between  possible  confiscation  and 
proper  regulation,  as  based  upon  the  value  of  the  prop- 
erty found  by  the  court  below,  and  the  division  depends 
upon  opinions  as  to  value,  which  differ  considerably  among 
the  witnesses,  and  also  upon  the  results  in  the  future  of 
operating  under  the  rate  objected  to,  so  that  the  material 
fact  of  value  is  left  in  much  doubt,  a  court  of  equity  ought 
not  to  interfere  by  injimction  before  a  fair  trial  has  been 
made  of  continuing  the  business  under  that  rate,  and  thus 
eliminating  as  far  as  is  possible,  the  doubt  arising  from 
opinions  as  opposed  to  facts. 

A  short  history  of  the  complainant,  as  to  its  incorpora- 
tion and  its  capital,  and  the  method  by  which  the  value 
of  its  franchises  was  arrived  at,  will  render  the  further 
examination  of  the  case  more  intelligible. 

Prior  to  1884  there  were  seven  gaslight  companies  in 
New  York  City,  each  operated  under  separate  charters, 
granted  at  different  times  between  the  years  1823  and  1865 
or  1871.  They  each  had  the  right  to  use  the  streets  of  cer- 
tain portions  of  the  city  for  the  purpose  of  la}dng  their 
mains  and  service  pipes  in  order  to  furnish  gas  to  the  city 
and  the  citizens.  Not  one  of  the  companies  had  ever  been 
called  upon  to  pay  a  penny  for  such  right,  but  the  grant 
to  each  was  in  that  aspect  a  gratuity.  It  was  not,  at  the 
time  of  granting  franchises  such  as  these,  the  custom  to 
pay  for  them. 

In  1884,  by  chapter  367  of  the  laws  of  that  year,  author- 
ity to  consolidate  manufacturing  corporations  was  granted 
upon  conditions  mentioned  in  the  act.  The  directors  of  the 
corporations  proposing  to  consolidate  were  to  make  an 
agreement  for  consolidation,  embracing,  among  other 
things,  the  amount  of  capital  and  the  number  of  shares  of 
stock  into  which  it  should  be  divided,  the  capital  not  to 
be  in  amount  more  ^'than  the  fair  aggregate  value  of  the 
property,  franchises  and  rights  of  the  several  companies 


452  SOME  JUDICIAL  DECISIONS 

to  be  consolidated."  The  agreement  was  not  to  be  valid 
until  submitted  to  the  stockholders  of  each  of  the  companies 
and  approved  by  two-thirds  of  each.  The  constituent  com- 
panies, which  were  afterwards  consolidated  under  their 
agreement,  and  pursuant  to  the  act  mentioned,  were  six 
in  number,  the  seventh,  the  Mutual  Company,  withdraw- 
ing. The  companies  agreed  upon  the  valuation  of  their 
property,  which  was  to  be  paid  for  in  the  stock  of  the  con- 
solidated company,  and  the  original  stock  held  by  the 
stockholders  of  each  company  was  surrendered  to  the  con- 
solidated company.  The  value  of  the  franchises  of  all  the 
companies  was  set  at  the  figure  of  $7,781,000.  Tlie  court 
below  said  that  the  master  reported  there  was  little  direct 
evidence  before  him  as  to  the  value  of  the  franchises,  to 
which  the  court  added  that  if  the  master,  by  direct  evi- 
dence, meant  testimony  of  the  same  kind  regarding  their 
value  as  had  been  offered  regarding  every  item  of  tangible 
property,  there  was  none  at  all. 

The  court  further  stated  "that  it  does  not  appear  in 
the  evidence  how  the  valuation  of  the  franchises  was  meas- 
ured, or  why  the  figures  selected  were  chosen,  but  that  it 
was  true  that  when  complainant  was  organized,  in  1884, 
under  the  consolidation  statute,  which  in  terms  permitted 
it  to  acquire  the  property  and  franchises  of  the  other  com- 
panies, it  issued  stock  of  the  par  value  of  $7,781,000,  rep- 
resenting the  franchises  it  then  acquired  and  nothing  else, 
and  that  the  stock  was  held  by  purchasers,  who,  I  am  com- 
pelled to  think,  had  a  right  to  rely  upon  legal  protection 
for  legally  issued  stock."  It  is  not,  of  course,  contended 
there  was  special  stock  issued  for  this  particular  item, 
but  it  was  included  in  the  total  sum  for  which  the  consoli- 
dated company  issued  its  stock  and  upon  its  receipt  the 
stockholders  in  the  various  companies  surrendered  their 
stock  in  those  companies.  The  result  was  that  the  amount 
of  the  stock  issued  by  the  consolidated  company  was  in- 
creased by  $7,781,000,  representing  a  value  of  franchises 


&OME  JUDICIAL  DECISIONS  453 

which  was  agreed  upon  by  the  stockholders  in  the  com- 
panies, and  which  had  never  cost  any;  of  them  a  single 
penny. 

It  cannot  be  disputed  that  franchises  of  this  nature 
are  property  and  cannot  be  taken  or  used  by  others  with- 
out compensation.  Monongahela  Co.  v.  United  States,  148 
U.  S.  312;  People  v.  O'Brien,  111  N.  Y.,  1,  and  cases  cited. 
The  important  question  is  always  one  of  value.  Taking 
their  value  in  this  case  as  arrived  at  by  agreement  of  their 
owners,  at  the  time  of  the  consolidation,  that  value  has  been 
increased  by  the  finding  of  the  court  below  to  the  sum  of 
$12,000,000  at  the  time  of  the  commencement  of  this  suit. 
The  trial  court  said:  "If,  however,  complainant's  fran- 
chises were  worth  $7,781,000  in  1884,  and  its  tangible  prop- 
erty, at  the  same  time,  was  appraised  (as  appears  in  evi- 
dence) at  $30,000,000  (in  round  figures),  then  since  com- 
plainant's business  (in  sales  volume)  has,  in  twenty-three 
years,  almost  quadrupled,  and  its  tangible  assets  grown 
to  $47,000,000,  it  appears  to  me  that  a  fair  method  of  fixing 
value  of  the  franchises  in  1905  is  to  assume  the  same  growth 
in  value  for  the  franchises  as  is  demonstrated  by  the  evi- 
dence in  the  case  of  tangible  property.  If,  therefore,  the 
franchise  valuation  of  1884  was  proportioned  to  person- 
alty and  realty  of  $30,000,000,  a  franchise  valuation  pro- 
portioned to  $47,000,000  in  1905  would  be  over  $12,000,000. 
This,  I  think,  a  logical  result  from  the  assumption  I  am 
compelled  to  start  with,  i.  e.,  that  franchises  have  a  sep- 
arate and  independent  value.  But  there  is,  however,  no 
method  of  valuing  franchises,  except  by  a  consideration  of 
earnings;  earnings  must  be  proportioned  to  assets;  and  both 
kinds  of  assets,  tangible  and  intangible,  must  stand  upon 
the  same  plane  of  valuation;  having,  therefore,  a  measure 
of  growth  of  tangible  assets  from  1884  to  1905,  the  fran- 
chise assets  must  be  assumed  to  have  grown  in  the  same 
proportion.  I  find  that  the  value  of  complainant's  fran- 
chises at  the  date  of  inquiry  was  not  less  than  $12,000,000, 


454  SOME  JUDICIAL  DECISIONS 

making  a  total  valuation  of  $59,000,000,  upon  which  the 
probable  return  is  $3,030,000,  or  very  considerably  less  than 
6  per  cent."  The  judge  stated  his  own  views  as  opposed 
to  including  these  franchises  in  the  property  upon  the  value 
of  which  a  return  is  to  be  calculated  in  fixing  the  amount 
of  rates,  but  held  that  he  was  bound  by  decided  cases  to 
hold  against  his  personal  views. 

We  are  not  prepared  to  hold  with  the  court  below  as  to 
the  increased  value  which  it  attributes  to  the  franchises. 
It  is  not  only  too  much  a  matter  of  pure  speculation,  but 
we  think  it  is  also  opposed  to  the  principle  upon  which 
such  valuation  should  be  made.  This  corporation  is  one 
of  that  class  which  is  subject  to  regulation  by  the  legis- 
lature in  the  matter  of  rates,  provided  they  are  not  made 
so  low  as  to  be  confiscatory.  The  franchises  granted  the 
various  companies  and  held  by  complainant  consisted  in 
the  right  to  open  the  streets  of  the  city  and  lay  down  mains 
and  use  them  to  supply  gas,  subject  to  the  legislative  right 
to  so  regulate  the  price  for  the  gas  as  to  permit  not  more 
than  a  fair  return  (regard  being  had  to  the  risk  of  the 
business)  upon  the  reasonable  value  of  the  property  at 
the  time  it  is  being  used  for  the  public. 

The  evidence  shows  that  from  their  creation,  down  to 
the  consolidation  in  1884,  these  companies  had  been  free 
from  legislative  regulation  upon  the  amount  of  the  rates 
to  be  charged  for  gas.  They  had  been  most  prosperous 
and  had  divided  very  large  earnings  in  the  shape  of  divi- 
dends to  their  stockholders,  dividends  which  are  charac- 
terized by  the  Senate  committee,  appointed  in  1885  to  in- 
vestigate the  facts  surroimding  the  consolidation,  as  enor- 
mous. The  report  of  that  committee  shows  that  several  of 
the  companies  had  averaged,  from  their  creation,  dividends 
over  16  per  cent,  and  the  six  companies  in  the  year  1884 
paid  a  dividend  upon  capital  which  had  been  increased 
by  earnings,  as  in  the  case  of  the  Manhattan  and  the  New 


SOME  JUDICIAL  DECISIONS  455 

York,  of  18  per  cent,  and,  had  it  been  upon  the  money 
actually  paid  in,  it  would  have  been  nearly  25  per  cent. 

The  committee  also  said  in  the  same  report  that  these 
' 'franchises  were  in  force  November  10,  1884,  the  time  of 
the  consolidation,  and  the  money  invested  in  them  was 
earning  the  same  enormous  dividends.  So  far  as  the  evi- 
dence shows,  there  was  nothing  in  the  condition  of  affairs 
on  the  10th  of  November  to  indicate  that  these  franchises 
would  not  be  as  valuable  for  the  next  twenty  years  as  they 
had  been  in  the  past.  There  were  gas  companies  enough 
in  the  city  with  a  capacity  capable  of  supplying  the  de- 
mands for  the  next  twenty  years.  A  law  was  on  our  stat- 
ute books  that  actually  prohibited  the  laying  of  any  more 
gas  pipes  in  the  streets.  The  gas  companies  had  an  agree- 
ment among  themselves,  fixing  the  price  of  gas  at  a  figure 
that  paid  these  dividends.  The  people  were  paying  this 
price,  as  they  had  in  the  past,  without  objection  or  pro- 
test. This  price  may  have  been  too  high,  and  the  divi- 
dends were  excessive,  but  they  were  not  illegal,  and  the 
valuation  of  the  franchises  computed  upon  these  dividends, 
and  that  state  of  facts  cannot  be  called  a  violation  of  a 
law  that  expressly  authorized  it  to  be  done,  unless  such 
valuation  was  too  high." 

The  committee,  upon  these  facts,  were  of  opinion  that 
the  valuation  of  $7,781,000  for  the  franchises  was  not  more 
than  their  fair  aggregate  value. 

Assuming,  as  the  committee  did,  that  the  company 
would  be  permitted  to  charge  the  same  prices  in  the  future 
which  in  the  past  had  resulted  in  these  *' enormous"  or 
*' excessive"  dividends,  it  need  not  be  matter  of  surprise 
that  a  franchise  by  means  of  which  such  dividends  had 
been  possible  was  not  regarded  as  overvalued  at  the  sum 
stated  in  1884. 

We  think  that  under  the  above  facts  the  courts  ought 
to  accept  the  valuation  of  the  franchises  fixed  and  agreed 
upon  under  the  act  of  1884  as  conclusive  at  that  time.    The 


456  SOME  JUDICIAL  DECISIONS 

valuation  was  provided  for  in  tlie  act,  which  was  followed 
by  the  companies,  and  the  agreement  regarding  it  has  been 
always  recognized  as  valid,  and  the  stock  has  been  largely 
dealt  in  for  more  than  twenty  years  past  on  the  basis  of 
the  validity  of  the  valuation  and  of  the  stock  issued  by 
the  company. 

But  although  the  state  ought,  for  these  reasons,  to  be 
bound  to  recognize  the  value  agreed  upon  in  1884  as  part 
of  the  property  upon  which  a  reasonable  return  can  be  de- 
manded, we  do  not  think  an  increase  in  that  valuation 
ought  to  be  allowed  upon  the  theory  suggested  by  the  court 
below.  Because  the  amount  of  gas  supplied  has  increased 
to  the  extent  stated,  and  the  other  and  tangible  property 
of  the  corporations  has  increased  so  largely  in  value,  is 
not,  as  it  seems  to  us,  any  reason  for  attributing  a  like  pro- 
portional increase  in  the  value  of  the  franchises.  Real 
estate  may  have  increased  in  value  very  largely,  as  also  the 
personal  property,  without  any  necessary  increase  in  the 
value  of  the  franchises.  Its  past  value  was  founded  upon 
the  opportunity  of  obtaining  these  enormous  and  excessive 
returns  upon  the  property  of  the  company,  without  legis- 
lative interference  with  the  price  for  the  supply  of  gas, 
but  that  immunity  for  the  future  was,  of  course,  uncertain, 
and  the  moment  it  ceased  and  the  legislature  reduced  the 
earnings  to  a  reasonable  sum  the  great  value  of  the  fran- 
chises would  be  at  once  and  unfavorably  affected,  but  how 
much  so  it  is  not  possible  for  us  now  to  see.  The  value 
would  most  certainly  not  increase.  The  question  of  the 
regulation  of  rates  did  from  time  to  time  thereafter  arise 
in  the  legislature,  and  finally  culminated  in  these  acts 
which  were  in  existence  w^hen  the  court  below  found  this 
increased  value  of  the  franchises.  We  cannot,  in  any  view 
of  the  case,  concur  in  that  finding. 

This  increase  in  value  did,  however,  form  part  of  the 
sum  upon  which  the  court  below  held  the  complainant  was 
entitled  to  a  return.    That  court  found  the  value  of  the 


SOME  JUDICIAL  DECISIONS  457 

tangible  assets  actually  employed  at  the  time  of  the  com- 
mencement of  this  suit  in  the  business  of  supplying  gas 
by  the  complainant  to  be  $47,831,435,  to  which  it  added 
the  $12,000,000  as  the  value  of  the  franchises  as  found  by 
it,  making  the  total  of  $59,831,435  upon  which  it  held  that 
the  company  was  entitled  to  a  return  of  6  per  cent,  being 
$3,589,886.10.  It  also  found  its  total  net  income  for  the  year 
1905  amounted  to  $5,881,192.45,  almost  10  per  cent  upon 
the  sum  above  named.  Altering  the  finding  of  the  court 
so  far  only  as  to  place  the  value  of  the  franchises  at  the 
time  agreed  upon  in  1884,  $7,781,000,  the  total  value  upon 
that  basis  of  the  property  employed  by  the  company  would 
be  $55,612,435,  upon  which  6  per  cent  would  be  $3,336,- 
746.10,  while  the  sum,  estimated  as  the  return  on  eighty- 
cent  gas  would  have  been  $3,024,592.14,  which  is  nearly  5^ 
per  cent  on  the  above  total  of  $55,612,435. 

What  has  been  said  herein  regarding  the  value  of  the 
franchises  in  this  case  has  been  necessarily  founded  upon 
its  own  peculiar  facts,  and  the  decision  thereon  can  form 
no  precedent  in  regard  to  the  valuation  of  franchises  gen- 
erally, where  the  facts  are  not  similar  to  those  in  the  case 
before  us.  We  simply  accept  the  sum  named  as  the  value 
under  the  circumstances  stated. 

There  is  no  particular  rate  of  compensation  which  must 
in  all  cases  and  in  all  parts  of  the  coimtry  be  regarded  as 
sufficient  for  capital  invested  in  business  enterprises.  Such 
compensation  must  depend  greatly  upon  circumstances  and 
locality;  among  other  things,  the  amount  of  risk  in  the 
business  is  a  most  important  factor,  as  well  as  the  locality 
where  the  business  is  conducted  and  the  rate  expected 
and  usually  realized  there  upon  investments  of  a  somewhat 
similar  nature  with  regard  to  the  risk  attending  them. 
There  may  be  other  matters  which  in  some  cases  might 
also  be  properly  taken  into  account  in  determining  the  rate 
which  an  investor  might  properly  expect  or  hope  to  receive 
and  which  he  would  be  entitled  to  without  legislative  inter- 


458  SOME  JUDICIAL  DECISIONS 

ference.  The  less  risk,  tlie  less  right  to  any  Tinusual  re- 
turns upon  the  investments.  One  who  invests  his  money 
in  a  business  of  a  somewhat  hazardous  character  is  very 
properly  held  to  have  the  right  to  a  larger  return  without 
legislative  interference,  than  can  be  obtained  from  an  in- 
vestment in  government  bonds  or  other  perfectly  safe  se- 
curity. The  man  that  invested  in  gas  stock  in  1823  had 
a  right  to  look  for  and  obtain,  if  possible,  a  much  greater 
rate  upon  his  investment  than  he  who  invested  in  such 
property  in  the  city  of  New  York  years  after  the  risk  and 
danger  involved  had  been  almost  entirely  eliminated. 

In  an  investment  in  a  gas  company,  such  as  complain- 
ant's, the  risk  is  reduced  almost  to  a  minimum.    It  is  a 
corporation,  which  in  fact,  as  the  court  below  remarks, 
monopolizes  the  gas  service  of  the  largest  city  in  America, 
and  is  secure  against  competition  under  the  circumstances 
in  which  it  is  placed,  because  it  is  a  proposition  almost 
unthinkable  that  the  city  of  New  York  would,  for  purposes 
of  making  competition,  permit  the  streets  of  the  city  to 
be  again  torn  up  in  order  to  allow  the  mains  of  another 
company  to  be  laid  all  through  th^tn  to  supply  gas  which 
the  present  company  can  adequately  supply.    And,  so  far 
as  it  is  given  us  to  look  into  the  future,  it  seems  as  certain 
as  anything  of  such  a  nature  can  be,  that  the  demand  for 
gas  will  increase,  and,  at  the  reduced  price,  increase  to 
a  considerable  extent.    An  interest  in  such  a  business  is 
as  near  a  safe  and  secure  investment  as  can  be  imagined 
wdth  regard  to  any  private  manufacturing  business,  al- 
though, it  is  recognized  at  the  same  time  that  there  is  a 
possible  element  of  risk,  even  in  such  a  business.     The 
court  below  regarded  it  as  the  most  favorably  situated  gas 
business  in  America,  and  added  that  all  gas  business  is 
inherently  subject  to  many  of  the  vicissitudes  of  manu- 
facturing.   Under  the  circumstances,  the  court  held  that 
a  rate  which  would  permit  a  return  of  6  per  cent  would 
be  enough  to  avoid  the  charge  of  confiscation,  and  for  the 


SOME  JUDICIAL  DECISIONS  459 

reason  that  a  return  of  such  an  amount  was  the  return 
ordinarily  sought  and  obtained  on  investments  of  that  de- 
gree of  safety  in  the  city  of  New  York. 

Taking  all  facts  into  consideration,  we  concur  with  the 
court  below  on  this  question,  and  think  complainant  is 
entitled  to  6  per  cent  on  the  fair  value  of  its  property 
devoted  to  the  public  use.  But  assuming  that  the  company 
is  entitled  to  6  per  cent  upon  the  value  of  its  property 
actually  used  for  the  public,  the  total  value  fixed  by  the 
court  below  is,  as  we  have  seen,  much  too  large.  We  must 
first  strike  out  the  increased  value  of  the  franchises  as- 
serted by  the  court  over  the  amount  agreed  upon  in  1884, 
when  the  companies  were  consolidated.  We  also  find  that 
the  total  value  of  the  tangible  property  is  made  up  of  sev- 
eral items,  two  of  which  are — 

Real    estate $11,985,435 

Plants     15,000,00 

Both  depend  largely  upon  the  opinions  of  expert  wit- 
nesses as  to  the  value  of  that  kind  of  property.  Where  a 
large  amount  of  the  total  value  of  a  mass  of  different  prop- 
erties consists  in  the  value  of  real  estate,  which  is  only 
ascertained  by  the  varying  opinions  of  expert  witnesses, 
and  where  the  opinions  of  the  plaintiffs'  witnesses  differ 
quite  radically  from  those  of  the  defendants',  it  is  apparent 
that  the  total  value  must  necessarily  be  more  or  less  in 
doubt.  It,  in  other  words,  becomes  matter  of  speculation 
or  conjecture  to  a  great  extent.  It  may  be,  as  already  sug- 
gested, that  in  many  cases  the  rates  objected  to  might  be 
so  low  that  there  could  be  no  reasonable  doubt  of  their 
inadequacy  upon  any  fair  estimate  of  the  value  of  the  prop- 
erty. In  such  event  the  enforcement  of  the  rates  should 
be  enjoined  even  in  a  case  where  the  value  of  the  property 
depends  upon  the  value  to  be  assigned  to  real  estate  by  the 
evidence  of  experts.  But  there  may  be  other  cases  where 
the  evidence  as  to  the  probable  result  of  the  rates  in  con- 
troversy would  show  they  were  so  nearly  adequate  that 


460  SOME  JUDICIAL  DECISIONS 

nothing  but  a  practical  test  could  satisfy  the  doubt  as  to 
their  sufficiency. 

In  this  case  a  slight  reduction  in  the  estimated  value 
of  the  real  estate,  plants  and  mains,  as  given  by  the  wit- 
nesses for  complainant,  would  give  a  6  per  cent  return 
upon  the  total  value  of  the  property  as  above  stated.  And 
again,  increased  consumption  at  the  lower  rate  might  re- 
sult in  increased  earnings,  as  the  cost  of  furnishing  the 
gas  would  not  increase  in  proportion  to  the  increased 
amount  of  gas  furnished. 

Tlie  elevated  railroads  in  New  York  when  first  built 
charged  ten  cents  for  each  passenger,  but  when  the  rate 
was  reduced  to  five  cents  it  is  common  knowledge  that 
their  receipts  were  not  cut  in  two,  but  that  from  increased 
patronage  the  earnings  increased  from  year  to  year,  and 
soon  surpassed  the  highest  sum  ever  received  upon  the 
ten-cent  rate. 

Of  course,  there  is  always  a  point  below  which  a  rate 
could  not  be  reduced  and  at  the  same  time  permit  the  proper 
return  on  the  value  of  the  property,  but  it  is  equally  true 
that  a  reduction  in  rates  will  not  always  reduce  the  net 
earnings,  but  on  the  contrary  may  increase  them.  The 
question  of  how  much  an  increased  consumption  under  a 
less  rate  will  increase  the  earnings  of  complainant,  if  at 
all,  at  a  cost  not  proportioned  to  the  former  cost,  can  be 
answered  only  by  a  practical  test.  In  such  a  case  as  this, 
where  the  other  data  upon  which  the  computation  of  the 
rate  of  return  must  be  based,  are  from  the  evidence  so 
uncertain,  and  where  the  margin  between  possible  confisca- 
tion and  valid  regulation  is  so  narrow  we  cannot  say  there 
is  no  fair  or  just  doubt  about  the  truth  of  the  allegation 
that  the  rates  are  insufficient. 

The  complainant  also  contends  that  the  state  having 
taxed  it  upon  its  franchises  cannot  be  heard  to  deny  their 
existence  or  their  value  as  taxed. 

The  fact  that  the  state  has  taxed  the  company  upon 


SOME  JUDICIAL  DECISIONS  461 

its  franchises  at  a  greater  value  than  is  awarded  them  here, 
is  not  material.  Those  taxes,  even  if  founded  upon  an 
erroneous  valuation,  were  properly  treated  by  the  company 
as  part  of  its  operating  expense,  to  be  paid  out  of  its  earn- 
ings before  the  net  amount  could  be  arrived  at  applicable 
to  dividends,  and  if  such  latter  sums  were  not  sufficient 
to  permit  the  proper  return  on  the  property  used  by  the 
company  for  the  public  then  the  rate  would  be  inadequate. 
The  future  assessment  of  the  value  of  the  franchises,  it 
is  presumed,  will  be  much  lessened  if  it  is  seen  that  the 
great  profits  upon  which  that  value  was  based  are  largely 
reduced  by  legislative  action.  In  that  way  the  consumer 
will  be  benefited  by  paying  a  reduced  sum  (although  in- 
directly) for  taxes. 

We  are  also  of  opinion  that  it  is  not  a  case  for  a  valu- 
ation of  ''good- will."  The  master  combined  the  franchise 
value  with  that  of  good-will,  and  estimated  the  total  value 
at  $20,000,000. 

The  complainant  has  a  monopoly  in  fact,  and  a  con- 
sumer must  take  gas  from  it  or  go  without.  He  will  resort 
to  the  ''old  stand,"  because  he  cannot  get  gas  anywhere 
else.  The  court  below  excluded ,  that  item,  and  we  concur 
in  that  action. 

And  we  concur  with  the  court  below  in  holding  that  the 
value  of  the  property  is  to  be  determined  as  of  the  time 
when  the  inquiry  is  made  regarding  the  rates.  If  the  prop- 
erty, which  legally  enters  into  the  consideration  of  the 
question  of  rates,  has  increased  in  value  since  it  was  ac- 
quired, the  company  is  entitled  to  the  benefit  of  such  in- 
crease. This  is,  at  any  rate,  the  general  rule.  We  do  not 
say  there  may  not  possibly  be  an  exception  to  it,  where 
the  property  may  have  increased  so  enormously  in  value 
as  to  render  a  rate  permitting  a  reasonable  return  upon 
such  increased  value  unjust  to  the  public.  How  such  facts 
should  be  treated  is  not  a  question  now  before  us,  as  this 
case  does  not  present  it.    We  refer  to  the  matter  only  for 


462  SOME  JUDICIAL  DECISIONS 

the  purpose  of  stating  that  the  decision  herein  does  not 
prevent  an  inquiry  into  the  question  when,  if  ever,  it  should 
be  necessarily  presented. 

The  matter  of  the  increased  cost  of  the  gas,  resulting 
from  the  provisions  of  the  acts,  as  to  making  the  gas  equal 
to  22  candle-power,  is  also  alleged  as  a  reason  for  inade- 
quacy of  rate. 

It  appears  that  th6  average  candle-power  actually  pro- 
duced in  the  first  six  months  of  the  year  1905  was  22,  while 
but  20  candle-power  was  exacted  by  law,  and  for  the  last 
six  months  of  that  year,  while  22  candle-power  was  ex- 
acted, the  average  amount  was  24.19.  This  expense  was 
included  in  the  operating  expense  of  that  year,  which  re- 
sulted in  the  net  earnings  above  mentioned,  while  the  com- 
pany was  complying  with  the  requirements  of  the  act  in 
this  particular. 

It  is  unnecessary,  therefore,  to  further  inquire  as  to 
the  additional  expense  caused  by  this  requirement. 

Again,  it  has  been  asserted  that  the  laws  are  unconsti- 
tutional, because  of  the  provision  as  to  pressure,  and  also 
by  reason  of  the  penalties  which  a  violation  of  the  acts 
may  render  a  corporation  liable  to. 

The  acts  provide  that  the  pressure  of  the  gas  in  ser^dce 
mains  at  any  distance  from  the  place  of  manufacture  shall 
not  be  less  than  one  inch  or  more  than  two  and  a  half 
inches. 

The  evidence  shows  that  to  put  a  pressure  such  as  is 
demanded  by  the  acts  upon  the  mains  and  other  service 
pipes  in  their  present  condition  would  be  to  run  a  great 
risk  of  explosion,  and  consequent  disaster.  Before  com- 
pliance with  this  provision  would  be  safe  the  mains  and 
other  pipes  would  have  to  be  strengthened  throughout  their 
whole  extent,  and  at  an  expenditure  of  many  millions  of 
dollars,  from  which  no  return  could  be  obtained  at  the  rates 
provided  in  the  acts.  This  would  take  from  the  complain- 
ant the  ability  to  secure  the  return  to  which  it  is  entitled 


SOME  JUDICIAL  DECISIONS  463 

upon  its  property,  used  for  supplying  gas,  and  the  provi- 
sions as  to  the  amount  of  pressure  is  therefore  void.  This 
particular  duty  imposed  by  the  acts  is,  however,  clearly 
separable  from  the  enactments  as  to  rates,  and  we  have 
no  doubt  that  the  remainder  of  the  statute  would  have 
been  enacted,  even  with  that  provision  omitted. 

The  obligation  would  remain  upon  the  company  to  have 
a  pressure  sufficient  to  insure  a  light  of  22  candle-power, 
as  provided  in  the  acts. 

We  are  of  the  same  opinion  as  to  the  penalties  provided 
for  a  violation  of  the  acts.  They  are  not  a  necessary  or 
inseparable  part  of  the  acts,  without  which  they  would 
not  have  been  passed.  If  these  provisions  as  to  penalties 
have  been  properly  constructed  by  the  court  below,  they 
undoubtedly  are  void,  within  the  principle  decided  in  Ex 
parte  Young,  209  IT.  S.  123,  and  the  cases  there  cited,  be- 
cause so  enormous  and  overwhelming  in  their  amount. 

When  the  objectionable  part  of  a  statute  is  eliminated, 
if  the  balance  is  valid  and  capable  of  being  carried  out, 
and  if  the  court  can  conclude  it  would  have  been  enacted 
if  that  portion  which  is  illegal  had  been  omitted,  the  re- 
mainder of  the  statute  thus  treated  is  good.  (Reagan  v. 
Trust  Co.,  154  U.  S.  362,  395;  Berea  College  v.  Common- 
wealth of  Kentucky,  211  IT.  S.  45,  54.)'  This  is  a  familiar 
principle. 

Lastly,  it  is  objected  that  there  is  an  illegal  discrimina- 
tion as  between  the  city  and  the  consumers  individually. 
We  see  no  discrimination  which  is  illegal  or  for  which  good 
reasons  could  not  be  given.  But  neither  the  city  nor  the 
consumers  are  finding  any  fault  with  it,  and  the  only  in- 
terest of  the  complainant  in  the  question  is  to  find  out 
whether,  by  the  reduced  price  to  the  city,  the  complainant 
is  upon  the  whole  unable  to  realize  a  return  sufficient  to 
comply  with  what  it  has  the  right  to  demand.  What  we 
have  already  said  applies  to  the  facts  now  in  question. 

We  cannot  see  from  the  whole  evidence  that  the  price 


464  SOME  JUDICIAL  DECISIONS 

fixed  for  gas  supplied  to  the  city  by  the  wholesale,  so  to 
speak,  would  so  reduce  the  profits  from  the  total  of  the 
gas  supplied  as  to  thereby  render  such  total  profits  insuffi- 
cient as  a  return  upon  the  property  used  by  the  complain- 
ant. So  long  as  the  total  is  enough  to  furnish  such  return 
it  is  not  important  that  with  relation  to  some  customers 
the  price  is  not  enough.  (Minneapolis,  etc.,  v.  Minnesota, 
186  U.  S.  257;  Atlantic  Coast  Line  v.  North  Carolina  Com- 
mission, 206  U.  S.  1.) 

Upon  a  careful  consideration  of  the  case  before  us  we 
are  of  opinion  that  the  complainant  has  failed  to  sustain 
the  burden  cast  upon  it  of  showing  beyond  any  just  or  fair 
doubt  that  the  acts  of  the  legislature  of  the  State  of  New 
York  are  in  fact  confiscatory. 

It  may  possibly  be,  however,  that  a  practical  expe- 
rience of  the  effect  of  the  acts  by  actual  operation  under 
them  might  prevent  the  complainant  from  obtaining  a  fair 
return,  as  already  described,  and  in  that  event  complain- 
ant ought  to  have  the  opportunity  of  again  presenting  its 
case  to  the  court.  To  that  end  we  reverse  the  decree,  with 
directions  to  dismiss  the  bill  without  prejudice,  and 

It  is  so  ordered. 


THE  BALANCE  SHEET  OF  A  RAILWAY 

INTRODUCTORY  LETTER. 


Interstate  Commerce  Commission, 
Bureau  of  Statistics  and  Accounts, 

Washington,  June  21,  1909, 

To  Carriers  Concerned : 

The  Form  of  General  Balance  Sheet  Statement  pro- 
mulgated .  .  .  will  be  incorporated  in  the  Forms  for 
Annual  Report  of  Carriers  to  the  Interstate  Commerce 
Commission  for  the  year  ending  June  30, 1910,  unless  modi- 
fied by  an  order  of  the  Commission  before  that  date.  In 
any  case,  carriers  whose  current  accounts  are  kept  in  such 
a  manner  as  to  enable  them  to  report  on  the  balance-sheet 
statement  herewith  promulgated  will  be  able  to  make  any 
balance-sheet  statement  which  the  Commission  may  finally 
accept  as  satisfactory. 

There  will  shortly  be  issued  a  Special  Report  Series 
Circular  calling  for  the  adjustment  of  assets  and  liabil- 
ities as  of  June  30,  1909,  to  the  form  of  balance-sheet 
statement  promulgated  under  the  present  order,  with  a 
view  of  (testing  its  practicability  and  of  collating  all  dif- 
ficulties incident  to  its  use.  Any  modification,  should 
modification  be  thought  desirable,  will  be  made  as  the 
result  of  this  test. 

Henry  C.  Adams, 
In  charge  of  Statistics  and  Accounts. 

FORM  OF  GENERAL  BALANCE  SHEET  STATEMENT. 

Assets. 
Property  Owned  as  Investment: 
I.  Physical  Property  Owned — 

465 
B— VIII— 8p 


466  A  RAILWAY  BALANCE  SHEET 

1-A.  Road  and  Equipment  to  June  30,  1907 — 

(a)  Road. 

(b)  Equipment. 

1-B.  Road  and  Equipment  since  June  30, 1907 — 

(a)  Road. 

(b)  Equipment. 

(c)  General  Expenditures. 
n.    Securities  Owned — 

2.  Securities   of  Proprietary,  Affiliated,  and  Con- 

trolled Companies — Pledged — 

(a)  Stocks. 

(b)  Funded  Debt. 

(c)  Miscellaneous. 

3.  Securities  Issued  or  Assumed — ^Pledged--^ 

(a)  Stocks. 

(b)  Funded  Debt. 
'(c)  Miscellaneous. 

'4.    Securities  of  Proprietary,  Affiliated,  and  Con- 
trolled Companies — Unpledged—^ 
(a)  Stocks. 
'(b)  Funded  Debt. 

(c)  Miscellaneous. 
m.  Investments — ■ 

5.  Advances   to  Proprietary,   Affiliated,   and   Con- 

trolled Companies  for  Construction,  Equip- 
ment, and  Betterments. 

6.  Other  Permanent  Investments — ' 

(a)  Physical  Property. 

(b)  Securities. 
Working  Assets: 

7.  Cash. 

8.  Marketable  Securities^- 

A.  Securities  Issued  or  Assumed — ^Unpledged — 
(a)  Stocks. 
'(b)  Funded  Debt, 
(c)  Miscellaneous. 


A  RAILWAY  BALANCE  SHEET  467 

B.  Other  Marketable  Securities— 

(a)  Stocks. 

(b)  Funded  Debt. 

(c)  Miscellaneous. 

9.  Loans  and  Bills  Receivable. 

10.  Net  Traffic,  Car  Mileage,  and  Per  Diem  Balance. 

11.  Net  Balance  Due  from  Agents  and  Conductors. 

12.  Miscellaneous  Accounts  Receivable. 

13.  Materials  and  Supplies. 

14.  Other  Working  Assets. 
Deferred  Debit  Items: 

15.  Advances — 

(a)  Advances  to  Proprietary,  Affiliated,  and  Con- 
trolled Companies. 

(b)  Working  Funds. 

(c)  Other  Advances. 

16.  Insurance  Premiums  Paid  in  Advance. 

17.  Taxes  Paid  in  Advance. 

18.  Discount  on  Securities  Issued — ■■ 

(a)  Discount  on  Stock. 

(b)  Discount  on  Funded  Debt. 

19.  Property  Abandoned,  Chargeable  to  Operating 

Expenses. 

20.  Cash  and  Securities  in  Sinking  and  Redemption 

Funds. 

21.  Cash  and  Securities  in  Insurance  and  Other  Spe- 

cial Funds. 

22.  Cash  and  Securities  in  Special  Trust  Funds. 

23.  Items  in  Suspense. 
Deficit: 

24.  Profit  and  Loss — ^Balance. 

Liabilities. 
Stock: 

25.  Capital  Stock — 

(a)  Common  Stock. 


468  A  RAILWAY  BALANCE  SHEET 

(b)  Preferred  Stock. 

(c)  Debenture  Stock. 

26.  Receipts  Outstanding  for  Capital  Stock. 

27.  Stock  Liability  for  Conversion  of  Outstanding  Se- 

curities of  Constituent  Companies. 

28.  Premium  Realized  on  Capital  Stock  Sold. 
Mortgage,  Bonded,  and  Secured  Debt: 

29.  Funded  Debt— 

(a)  Mortgage  Bonds. 

(b)  Collateral  Trust  Bonds. 

(c)  Plain  Bonds,  Debentures,  and  Notes. 

(d)  Income  Bonds. 

(e)  Equipment  Trust  Obligations. 

(f)  Miscellaneous  Funded  Obligations. 

30.  Receipts  Outstanding  for  Funded  Debt. 

31.  Premium  Realized  on  Funded  Debt  Sold. 

32.  Receivers'  Certificates. 

33.  Obligations  for  Advances  Received  for  Construc- 
tion, Equipment,  and  Betterments. 

Working  Liabilities: 

34.  Loans  and  Bills  Payable. 

35.  Net  Traffic,  Car  Mileage,  and  Per  Diem  Balance. 

36.  Audited  Vouchers  and  Wages  Unpaid. 

37.  Miscellaneous  Accounts  Payable. 

38.  Matured  Dividends,  Interest,  and  Rents  Unpaid. 

39.  Matured  Mortgage,  Bonded,  and  Secured  Debt 
Unpaid. 

40.  Working  Advances  Due  to  Otber  Companies. 

41.  Other  Working  Liabilities. 
Accrued  Liabilities  Not  Due: 

42.  Dividends  Declared  and  Interest  and  Rents  Ac- 

crued, Not  Due. 

43.  Taxes  Accrued. 
Deferred  Credit  Items: 

44.  Operating  Reserves — 

(a)  Reserves  for  Replacement  of  Property. 


A  RAILWAY  BALANCE  SHEET  469 

(b)  Eeserves  for  Other  Purposes. 

45.  Liability  on  Account  of  Special  Trust  Funds. 

46.  Items  in  Suspense. 
Appropriated  Surplus: 

47.  Surplus  Reserves — 

(a)  Reserves  Invested  in  Sinking  and  Redemp- 
tion Funds. 

(b)  Reserves  Invested  in  Insurance  and  Other 
Special  Funds. 

(c)  Reserves  Not  Specifically  Invested. 

48.  Additions    to    Property    through    Income    since 

June  30,  1907. 
Free  Surplus: 

49.  Profit  and  Loss — Balance. 

TEXT   EXPLANATORY   OF   BALANCE   SHEET 

ACCOUNTS. 

Assets. 

Property  Owned  as  Investment. 

I.  Physical  Property  Owned. 

1-A.  Road  and  Equipment  to  June  30,  1907. 

This  account  should  include  the  balances  carried 
in  the  General  Ledger  showing  the  value  of  Road 
and  Equipment  as  it  stood  on  June  30,  1907,  sub- 
divided between  (a)  Road  and  (b)  Equipment,  when 
the  subdivision  can  be  accurately  made. 

1-B.  Road  and  Equipment  since  June  30,  1907. 

This  account  should  include  amounts  expended 
and  charged  in  accordance  with  the  Classifications 
of  Expenditures  for  Road  and  Equipment  and  Ex- 
penditures for  Additions  and  Betterments  since 
June  30,  1907.  These  amounts  should  be  subclassi- 
fied:  (a)  Road,  (b)  Equipment,  (c)  General  Expend- 
itures. 

II.  Securities  Owned. 


470  A  RAILWAY  BALANCE  SHEET 

2.  Securities  of  Proprietary,  Affiliated,  and  Con- 
trolled Companies — ^Pledged. 
This  account  should  include  the  book  value  of 
securities  of  proprietary,  affiliated,  and  controlled 
companies  whose  property  is  used  by  or  forms  a 
part  of  the  railway  system  of  the  respondent  com- 
pany, which  securities  are  pledged  as  collateral  se- 
curity for  any  of  the  respondent  company's  funded 
debt  or  other  outstanding  obligations.  It  should  in- 
clude securities  of  union  depot,  terminal,  bridge, 
ferry,  and  similar  companies  owned  by  the  respond- 
ent company  and  pledged  to  secure  its  outstanding 
obligations  when  the  property  of  those  companies 
is  used  by  the  respondent  company  in  the  transac- 
tion of  its  own  transportation  business. 

Amounts  reported  in  this  account  should  be  classi- 
fied under  the  subheadings :  (a)  Stocks,  (b)  Funded 
Debt,  (c)  Miscellaneous. 

See  text  of  accounts  Nos.  25  and  29  for  descrip- 
tion of  items  classed  as  ** Capital  Stock"  and  *' Fund- 
ed Debt."  Among  the  items  that  should  be  classed 
as  ** Miscellaneous"  are  receivers'  certificates  and  de- 
mand or  short-time  notes  issued  by  proprietary  com- 
panies, which  do  not  come  within  the  character  of 
obligations  classed  as  funded  debt. 
9.  Securities  Issued  or  Assumed — Pledged. 

This  account  should  include  the  book  value  of  se- 
curities issued  by  the  respondent  company,  and  se- 
curities issued  by  other  companies,  payment  having 
been  assumed  by  the  respondent  company,  which 
have  been  pledged  as  collateral  for  other  securities 
issued  by  the  respondent  company. 

The  par  value  of  securities  reported  under  this 
caption  should  be  included  in  the  amount  of  capital 
stock  or  funded  debt  of  the  respondent  company 


A  RAILWAY  BALANCE  SHEET  471 

under  general  account  ''Stock"  or  ** Mortgage,  Bond- 
ed, and  Secured  Debt." 

Amounts  reported  under  this  caption  should  be 
classified  under  the  subheadings:  (a)  Stocks,  (b) 
Funded  Debt,  (c)  Miscellaneous. 

See  text  of  account  No.  25,  "Capital  Stock,"  and 
No.  29,  ''Funded  Debt,"  for  description  of  items 
classed  under  subheadings  (a)  Stocks  and  (b)  Fund- 
ed Debt.  Under  subheading  (c)  Miscellaneous 
should  be  grouped  the  balances  representing  issued 
or  assumed  obligations  (other  than  stocks,  bonds,  or 
certificates  of  indebtedness  maturing  more  than  one 
year  after  date  of  issue)  which  are  owned  by  the 
respondent  company  and  pledged  by  it  as  collateral 
security. 

Note. — This    account    is    not    intended    to    cover    securities 
guaranteed  only. 

4.  Securities  of  Proprietary,  Affiliated,  and  Controlled 
Companies — Unpledged. 

This  account  should  include  the  book  value  of  un- 
pledged securities  of  proprietary,  affiliated,  or  con- 
trolled companies  whose  property  is  used  by  or  forms 
a  part  of  the  railway  system  of  the  respondent  com- 
pany, the  securities  being  held  for  the  purpose  of 
preserving  the  integrity  of  the  system.  There  should 
be  included  under  this  caption  the  book  value  of 
investments  in  the  securities  of  union  depot,  termi- 
nal, bridge,  ferry,  and  similar  companies  when  the 
property  of  those  companies  is  used  by  the  respond- 
ent company  in  the  transaction  of  its  own  transpor- 
tation business  and  said  securities  are  in  its  treasury 
unpledged. 

Amounts  reported  in  this  account  should  be  classi- 
fied under  the  subheadings:  '(a J  Stocks,  (h)  Funded 
Debt,  (c)  Miscellaneous. 


472  A  RAILWAY  BALANCE  SHEET 

See  text  of  account  No.  2  for  description  of  items 
classed  as  Miscellaneous. 

Note. — This  account  is  not  intended  to  cover  securities 
guaranteed  only,  or  any  deemed  by  the  respondent  company  as 
"Marketable  Securities." 

m.  Investments. 

5.  Advances  to  Proprietary,  Affiliated,  and  Controlled 
Companies  for  Construction,  Equipment,  and 
Betterments. 

Except  as  provided  below,  there  should  be  included 
in  this  account  all  cash  advances  made  to  proprie- 
tary, affiliated,  and  controlled  companies  to  enable 
said  companies  to  pay  for  construction,  equipment, 
and  additions  and  betterments,  which  advances  may 
be  carried  in  open  accounts  by  the  respondent  com- 
pany. When  the  companies  to  which  said  advances 
are  made  issue  notes  or  other  securities  to  the  re- 
spondent company  for  the  payment  of  said  advances, 
the  cost  of  said  notes  or  securities  should  be  trans- 
ferred from  this  account  to  account  No.  2,  if  said 
securities  are  pledged  as  collateral  for  obligations 
issued,  or  to  be  issued,  by  the  respondent  company, 
or  to  account  No.  4  if  held  unpledged. 

In  case  advances  are  made  to  proprietary,  affili- 
ated, or  controlled  companies  for  the  purposes  above 
mentioned,  with  the  understanding  and  intention 
that  the  advances  shall  be  liquidated  by  the  company 
to  which  made,  either  in  cash  realized  from  the  issu- 
ance and  sale  of  its  own  securities,  or  by  the  issuance 
of  securities  to  the  respondent  company,  which  the 
latter  may  sell  or  hold  in  its  treasury  as  free  assets 
at  its  pleasure,  the  amounts  so  advanced  should  be 
included  in  account  No.  15,  ** Advances." 
G.  Other  Permanent  Investments. 

(ay  Physical  Property. — This  account  should  in- 
clude investments  in  property  not  used  for  railway 
purposes  or  outside  operations,  such  as  coal  and  other 


A  RAILWAY  BALANCE  SHEET  473 

mines,  timber  lands,  sawmills,  hotels  (not  a  part  of 
the  railway  property)  with  their  furniture  and  fit- 
tings, buildings  and  property  used  for  commercial 
purposes;  land  scrip  acquired  for  the  purpose  of 
locating  upon  and  securing  title  to  public  lands;  in- 
vestments in  property  not  used  for  railway  purposes 
and  for  which  no  titles  or  securities  for  titles  are 
held;  and  other  property  that  has  been  acquired  in 
anticipation  of  future  necessity  or  use,  but  which 
is  not  at  present  a  part  of  the  carrier's  property 
used  in  carrying  on  its  transportation  business  or 
outside  operations. 

(b)  Securities — This  account  should  include  invest- 
ments in  the  securities  of  steamship  lines,  express 
companies,  or  other  enterprises  which  it  is  necessary 
or  desirable  for  the  respondent  company  to  control 
or  to  be  interested  in  for  the  purpose  of  maintain- 
ing the  integrity  of  its  transportation  system,  pro- 
vided such  securities  be  not  considered  ^'Marketable 
Securities"  (account  No.  8).  This  account  should 
also  include  securities,  not  provided  for  in  accounts 
Nos.  2,  3,  and  4,  and  may  be  pledged  in  connection 
with  mortgage,  bonded,  and  secured  debt  (see  ac- 
counts Nos.  29  and  33) ;  also  memberships  in  boards 
of  trade  and  other  commercial  organizations  when 
such  memberships  have  a  permanent  value. 
Working  Assets. 

7.  Cash. 

This  account  should  include  current  funds  in  the 
hands  of  financial  officers  and  agents,  deposits  in 
banks  or  trust  companies  available  for  use  on  de- 
mand, including  deposits  to  pay  declared  dividends 
or  matured  coupons,  and  cash  in  transit  for  which 
agents  and  conductors  receive  current  credit. 

8.  Marketable  Securities. 

This  account  should  include  the  cost  or  book  value 


474  A  RAILWAY  BALANCE  SHEET 

of  all  securities  which  are  held  in  the  company's 
treasury  unpledged  and  free  for  sale  and  which  it 
is  not  necessary  or  desirable  for  the  respondent  com- 
pany to  hold  for  the  purpose  of  maintaining  the 
integrity  of  its  railway  system.  Such  securities 
should  be  subdivided  to  show: 

A.  Securities  held  in  the  treasury  of  the  respond- 
ent company,  w^hether  securities  of  its  own  issue  or 
securities  the  payment  of  which  it  has  assumed. 

B.  Other  securities. 

These  securities  should  be  further  classified  as 
stocks,  funded  debt,  and  miscellaneous. 

Note. — The  par  value  of  securities  entered  under  A  should  be 
included  under  accounts  Nos.  25  and  29,  "Capital  Stock"  and 
"Funded  Debt." 

9.  Loans  and  Bills  Receivable. 

This  account  should  include  the  book  value  of  all 
collectible  obligations  in  the  form  of  loans  and  bills 
receivable  or  other  similar  evidences  of  money  receiv- 
able on  demand  or  within  a  time  not  exceeding  one 
year. 

Note. — This  does  not  include  time  loans  which  mature  more 
than  one  year  after  date  of  issue,  considered  as  investrnents,  or 
loans  to  proprietary,  affiliated,  or  controlled  companies,  such 
as  are  described  under  accounts  Nos.  5  and  15a. 

10.  Net  Traffic,  Car  Mileage,  and  Per  Diem  Balance. 
This  account  should  include  the  net  amounts  due 

from  other  companies  on  account  of  interline  freight 
and  ticket  balances  and  balances  resulting  from  the 
interchange  of  cars  on  a  per  diem  or  a  mileage  basis. 
Amounts  due  to  the  owners  of  private  cars  for  per 
diem  or  mileage  on  cars  should  be  considered  the 
same  as  amounts  due  to  other  railway  companies. 

11.  Net  Balance  Due  from  Agents  and  Conductors. 
This  account  should  include  the  net  balance  due 

in  current  accounts  from  agents,  and  train,  sleeping- 
car,  and  dining-car  conductors,  train  auditors,  por- 
ters, and  others.    Amounts  advanced  to  general  and 


A  RAILWAY  BALANCE  SHEET  475 

special  agents  as  working  funds  should  not  be  in- 
cluded. 

12.  Miscellaneous  Accounts  Receivable. 

This  account  should  include  amounts  due  for 
audited  accounts,  such  as  those  due  from  the  United 
States  or  other  governments  for  transportation  of 
mails  and  government  property,  and  from  express 
companies  for  express  facilities  furnished  under  con- 
tract; miscellaneous  bills  against  other  railway  com- 
panies, corporations,  firms,  and  individuals;  ground 
rents  collectible;  interest  collectible  on  bills  and  ac- 
counts receivable,  and  on  mortgages,  deposits,  and 
securities;  and  other  similar  items. 

Note. — The  amount  to  be  reported  under  this  account  is  not 
the  net  balance  between  accounts  Nos.  13  and  37. 

13.  Materials  and  Supplies. 

This  account  should  include  the  balances  repre- 
senting the  value  of  all  unapplied  material,  and  the 
value  of  material  temporarily  in  use  and  not  charged 
out,  such  as  articles  in  process  of  manufacture  by 
the  company;  telegraph  and  telephone  material;  fuel; 
stationery;  dining-car  supplies,  etc. 

14.  Other  Working  Assets. 

This  account  should  include  items  of  working  as- 
sets not  covered  by  accounts  Nos.  7  to  13,  inclusive. 
It  is  intended  to  include  asset  items  that  have  not 
reached  the  stage  of  audited  accounts  properly 
classed  under  account  No.  12,  "Miscellaneous  Ac- 
counts Receivable,"  and  yet  have  been  advanced  be- 
yond the  stage  of  accounts  properly  classed  under 
account  No.  23,  "Items  in  Suspense."  This  account 
includes  such  items  as  fijaes  imposed  by  postal  au- 
thorities in  process  of  collection  from  parties  at  fault ; 
amounts  due  from  other  roads  for  mileage  or  tickets 
honored  for  which  reports  or  accounts  have  not  been 
rendered  or  received;  advanced  charges  billed  out 


476  A  RAILWAY  BALANCE  SHEET 

on  waybills  not  reported  received  at  the  end  of  the 
month,  and  similar  items. 
Deferred  Debit  Items. 
15.  Advances. 

(a)  Advances  to  Proprietary,  Affiliated,  and  Con- 
trolled Companies. — This  account  should  include 
amounts  advanced  to  proprietary  and  subsidiary 
companies  for  purposes  other  than  construction, 
purchase  of  equipment,  or  additions  and  betterments, 
as  provided  for  in  account  No.  5.  It  should  include 
advances  on  open  account  for  the  purpose  of  pay- 
ing interest  on  the  funded  debt  of  proprietary  or 
subsidiary  companies,  deficits  resulting  from  the 
operations  of  such  companies,  and  other  advances 
not  to  be  included  in  capital  account  and  not  repre- 
sented by  the  physical  property  of  said  proprietary 
or  subsidiary  companies. 

There  should  also  be  included  in  this  subdivision 
amounts  advanced  to  proprietary,  affiliated,  or  con- 
trolled companies  to  enable  such  companies  to  pay 
construction,  equipment,  and  additions  and  better- 
ments expenditures  when  it  is  the  understanding  or 
intention  that  the  advances  shall  be  liquidated  by 
the  company  to  which  made,  either  in  cash  realized 
from  the  issuance  and  sale  of  its  securities,  or  by 
the  issuance  of  its  securities  to  the  company  making 
the  advances,  which  securities  the  latter  company 
may  sell  or  hold  in  its  treasury  as  free  assets  at  its 
pleasure,  it  being  considered  not  necessary  that  the 
company  receiving  said  securities  shall  hold  them 
for  the  purpose  of  maintaining  the  integrity  of  its 
railway  system.     (See  accounts  N"os.  2,  3,  and  4). 

(b)  Working  Funds. — This  account  should  in- 
clude amounts  advanced  to  general  and  special 
agents,  officers  and  employes  of  the  engineering  de- 
partment, and  other  officers  and  employes  as  work- 


A  RAILWAY  BALANCE  SHEET  477 

ing  funds  from  which  certain  expenditures  are  to 
be  made  and  accounted  for  by  the  persons  to  whom 
the  advances  are  made.  It  also  includes  advances 
to  fast  freight  lines  and  union  depot  and  other  ter- 
minal companies  as  working  funds  to  be  used  in 
paying  the  current  expenses  of  such  companies  in 
advance  of  regular  monthly  settlements. 

(c)  Other  Advances. — This  account  should  include 
other  advances  not  properly  classified  under  (a)  and 
(b)  above  or  under  account  No.  5,  *' Advances  to 
Proprietary,  Affiliated,  and  Controlled  Companies  for 
Construction,  Equipment,  and  Betterments." 

16.  Insurance  Premiums  Paid  in  Advance. 

This  account  should  include  the  debit  balances  rep- 
resenting premiums  paid  in  advance  for  fire,  boiler, 
accident,  plate  glass,  liability,  and  kindred  insurance, 
to  be  absorbed  by  monthly  charges  to  operating  ex- 
penses and  outside  operations  during  the  term  of 
the  insurance. 

il7.  Taxes  Paid  in  Advance. 

This  account  should  include  the  excess  of  taxes 
paid  over  the  proportion  accrued  against  the  income 
of  the  period  covered. 

18.  Discount  on  Securities  Issued. 

(a)  Discount  on  Stock. — ^When  stocks,  included 
under  account  No.  25  at  their  par  value,  are  issued 
or  sold  at  a  discount,  the  discount  should  be  reported 
in  this  account  and,  if  the  stock  is  not  to  be  retired 
or  converted,  carried  on  the  balance  sheet  perma- 
nently or  until  extinguished  by  premiums  realized 
on  subsequent  sales  of  the  same  class  of  stock.  If 
the  stock  is  to  be  retired  or  converted,  the  discount 
should  be  charged  to  Profit  and  Loss  or  against  the 
premium  realized,  if  any,  at  the  date  of  such  retire- 
ment or  conversion. 
If  the  premium  in  account  No.  28,  '^Premium 


478  A  RAILWAY  BALANCE  SHEET 

Realized  on  Capital  Stock  Sold,"  is  less  in  amount 
than  the  discount  included  in  this  account,  it  should 
be  deducted  herefrom  and  the  net  amount  included 
in  this  account.  If  the  premium  in  account  No.  28 
is  greater  than  the  discount  charged  in  this  account, 
the  discount  should  be  deducted  therefrom  and  the 
difference  included  in  account  No.  28. 

(b)  Discount  on  Funded  Debt. — When  bonds  are 
Issued  or  sold  at  a  discount  they  should  be  included 
in  account  No.  29,  *' Funded  Debt,"  at  their  par 
value.  The  discount  should  be  charged  to  Income 
in  such  equal  annual  installments  during  the  life  of 
the  bonds  as  will  extinguish  the  discount.  The  car- 
rier may,  however,  at  its  option,  charge  to  Profit 
and  Loss  all  of  the  discount  or  any  part  of  it  remain- 
ing at  any  time  unextinguished;  but  the  charge  to 
Income  in  any  one  year  must  not  exceed  the  amount 
of  the  annual  installment  applicable  to  that  year. 
The  discount  remaining  unextinguished  should  be  in- 
cluded in  this  account. 

If  the  premium  in  account  No.  31,  ^^  Premium 
Realized  on  Funded  Debt  Sold,"  is  less  in  amount 
than  the  discount  included  in  this  account,  it  should 
be  deducted  herefrom  and  the  net  amount  reported 
in  this  account.  If  the  premium  in  account  No.  31 
is  greater  than  the  discount  charged  in  this  account, 
the  discount  should  be  deducted  from  the  premium 
and  the  difference  included  in  account  No.  31. 
19.  Property  Abandoned,  Chargeable  to  Operating 
Expenses. 

This  account  is  intended  as  a  suspense  account  to 
which  may  be  charged  certain  costs  representing  im- 
portant pieces  of  property  abandoned  in  the  course 
of  improvement  or  betterment  work  when  the  cost 
of  such  property  would,  if  included  in  the  operating 
expenses  for  a  single  year,  unduly  burden  such  ac- 


A  RAILWAY  BALANCE  SHEET  479 

counts  for  that  year.  It  is  to  be  used  only  after  per- 
mission of  the  Interstate  Commerce  Commission  has 
been  asked  and  given  and  is  not  to  be  applied  to 
lands  abandoned  or  equipment  retired  from  service. 
Amounts  included  herein  are  to  be  redistributed  to 
operating  expenses  through  a  period  of  years,  the 
number  of  which  will  be  determined  when  permission 
to  use  the  account  is  granted. 

To  this  account  may  be  charged  the  cost,  less  sal- 
vage, of  replacing  in  kind  any  of  the  following  prop- 
erty: Station  buildings,  enginehouses,  turntables, 
shop  buildings,  and  terminal  yards,  including  build- 
ings and  other  structures  therein,  removed  or  aban- 
doned in  the  course  of  replacing  them  with  improved 
structures  or  facilities;  bridges  and  trestles  aban- 
doned by  reason  of  replacing  them  with  structures 
of  greater  capacity  or  permanency;  injterlocking  ap- 
paratus abandoned  in  the  course  of  eliminating  grade 
crossings  or  of  other  improvements ;  block  and  other 
signal  apparatus  replaced  with  improved  apparatus ; 
and  fuel  stations,  grain  elevators,  storage  ware- 
houses, docks,  wharves,  light  and  power  plants,  and 
all  other  important  miscellaneous  structures  aban- 
doned in  the  course  of  replacing  them  with  enlarged! 
or  improved  property. 

To  this  account  may  also  be  charged  the  cost,  less 
salvage,  of  main  line  and  sidings,  including  track 
material  abandoned  by  reason  of  change  of  line  or 
location;  and  the  cost,  less  salvage,  of  rails,  track 
fastenings,  and  frogs  and  switches  released  from 
track  on  account  of  relaying  with  heavier  rails.  For 
the  purposes  of  this  account  the  cost  of  replacing 
rails,  track  fastenings,  and  frogs  and  switches  should 
be  computed  upon  the  basis  of  the  cost  of  replac- 
ing the  original  weight  of  ,the  rails,  track  fastenings, 


480  A  RAILWAY  BALANCE  SHEET 

and  frogs  and  switches,  at  tlie  price  per  ton  paid  for 
the  material  put  in  anew. 

This  account  may  also  include  the  cost  of  remov- 
ing old  material  and  all  other  incidental  expenses 
directly  connected  with  the  abandonment  of  prop- 
erty the  cost  of  which  is  included  in  this  account. 

Note  A. — The  amount  charged  to  this  account  for  property- 
abandoned  should  be  concurrently  credited  to  the  appropriate 
accounts  under  Additions  and  Betterments. 

Note  B. — The  phrase  "unduly  burden  such  accounts,"  used 
above,  should  not  be  interpreted  as  meaning  that  a  carrier  is  at 
liberty  to  make  charges  for  abandoned  property  directly  to 
Operating  Expenses,  or  to  Operating  Expenses  through  the  ac- 
count "Property  Abandoned,  Chargeable  to  Operating  Expen- 
ses," in  view  of  its  financial  ability  to  make  such  charges 
directly  in  one  year  and  its  inability  to  make  such  charges  in 
'  another  year.     It  should  be  remembered  that  the  charges  in- 

I  eluded  in  Operating  Expenses  are  designed  to  cover  the  current 

cost  of  maintaining  and  operating  the  property,  and  that  the 
Property  Abandoned  accounts  are  designed  to  cover  any  un- 
usual expenditures  from  year  to  year. 

20.  Cash  and  Securities  in  Sinking  and  Eedemption 
i  Funds. 

This  account  should  include  the  amount  of  cash 
and  the  cost  or  book  value  of  live  securities  in  the 
hands  of  trusitees  of  sinking  and  other  funds  for  the 
purpose  of  redeeming  outstanding  obligations.  Any 
live  securities  of  the  respondent  company  held  by 
such  trustees  should  be  included  in  the  amounts  re- 
ported under  the  appropriate  subheadings  of  account 
No.  25,  ^'Capital  Stock,"  or  account  No.  29,  ^'Funded 
Deb,t." 

21.  Cash  and  Securities  in  Insurance  and  Other  Spe- 

cial Funds. 
This  account  should  include  the  ledger  balances 
covering  the  amount  of  cash  and  the  cost  of  securi- 
ties in  the  hands  of  trustees  or  managers  of  insurance 
funds,  pension  funds,  and  other  funds  that  have  been 
raised  by  the  carrier  for  specific  purposes  (except 
special  trust  funds  and  sinking  funds  for  the  retire- 
ment of  obligations).    The  amount  reported  in  this 


A  RAILWAY  BALANCE  SHEET  481 

account  should  agree  with  the  amount  reported  in 
account  No.  47b,  '^Keserves  Invested  in  Other  Spe- 
cial Funds." 

22.  Cash  and  Securities  in  Special  Trust  Funds. 
This  account  should  include  the  ledger  balances 

covering  ,the  amount  of  cash  and  the  cost  of  securi- 
ties in  the  hands  of  trustees  or  managers  of  em- 
ployes' savings  funds,  relief,  hospital,  and  other  asso- 
ciation funds  when  such  trustees  or  managers  are 
acting  for  the  carrier  in  the  administration  of  such 
funds.  If  such  funds  are  held  in  the  carrier's  treas- 
ury not  invested  and  uniden,tified  they  should  be  in- 
cluded in  account  No.  7,  '^Cash."  The  amount  re- 
ported in  this  account  should  agree  with  the  amount 
reported  in  account  No.  45,  *' Liability  on  Account 
of  Special  Trust  Funds." 

23.  Items  in  Suspense. 

In  this  account  should  be  included  suspense  ac- 
counts showing  debit  balances  that  cannot  be  en- 
tirely cleared  and  disposed  of  until  additional  infor- 
mation is  received,  such  as  freight  claims  paid  when 
found  to  be  correct  but  in  advance  of  investigation 
with  other  carriers;  charges  for  work  done  or  ma- 
terials furnished  for  which  bills  have  not  been  re- 
ceived from  the  proper  departments ;  items  awaiting 
adjustment  between  accounts,  such  as  cost  of  work 
done  in  advance  of  receipt  of  proper  authority  or 
appropriation;  accounts  covering  the  cost  of  opera- 
tion of  gravel  pits  and  quarries  to  be  apportioned 
on  output;  debit  balances  in  *^Shop  Expense"  and 
** Store  Expense"  accounts;  also  accounts  to  be 
spread  over  a  stated  term  not  provided  for  in  ac- 
count No.  18  or  elsewhere;  and  debit  balances  in 
operating  reserve  accounts  to  be  cleared  by;  future 
charges  to  operating  expenses. 

»— VIII— 31  " 


482  A  RAILWAY  BALANCE  SHEET  ' 

Deficit. 

24.  Profit  and  Loss — Balance. 

In  case  the  debit  balance  in  the  profit  and  loss 
account  is  less  than  the  total  of  accounts  Nos.  47 
and  48,  under  the  caption  ''Appropriated  Surplus," 
the  amounts  of  these  accounts  should  be  stated  in 
short  column  on  the  credit  side  of  the  balance  sheet 
and  the  total  brought  down.  From  this  total  should 
be  deducted  the  profit  and  loss  debit  balance  and 
the  net  amount  remaining  should  be  extended  as 
''Profit  and  Loss — Balance"  under  "Free  Surplus." 
If,  however,  the  debit  balance  of  the  profit  and  loss 
account  is  in  excess  of  the  total  of  accounts  Nos.  47 
and  48  the  amount  of  these  accounts  should  be  stated 
in  short  column  on  the  debit  side  of  the  balance  sheet 
and  the  total  deducted  from  the  profit  and  loss 
debit  balance,  the  difference  being  shown  as  "Profit 
and  Loss — Balance"  under  "Deficit." 

Liabilities. 
Stock. 

25.  Capital  Stock. 

In  this  account  should  be  entered  the  full  amount 
of  the  capital  stock  issued  and  outstanding,  whether 
all  or  any  part  of  same  is  held  by  the  public,  by 
other  railway  companies,  in  the  company's  treasury, 
pledged  or  unpledged,  or  by  the  trustees  of  sinking 
or  other  funds  for  the  redemption  of  outstanding 
obligations,  or  for  other  special  purposes.  The 
amounts  entered  in  this  account  should  be  subdivided 
as  follows: 

(a)  Common  Stock. — The  par  value  of  eonomon 
stock  issued  and  outstanding. 

(b)  Preferred  Stock. — The  par  value  of  first,  sec- 
ond, or  other  preferred  stock  issued  and  outstand- 
ing. 


A  RAILWAY  BALANCE  SHEET  483 

'(c)  Debenture  ^tock. — The  par  value  of  debenture 
stock  issued  and  outstanding. 

Note. — Capital  stock  is  considered  as  "issued"  when  cer- 
tificates are  signed,  sealed,  and  placed  with  the  proper  officer 
for  sale  and  delivery.  All  capital  stock  issued  and  not  canceled 
is  considered  to  be  "outstanding." 

26.  Eeceipts  Outstanding  for  Capital  Stock. 

When  capital  stock  is  sold,  to  be  paid  for  in  in- 
stallments, the  amounts  received  in  such  install- 
ments should  be  included  in  this  account.  When 
such  stock  has  been  paid  for  in  full,  and  the  receipts 
given  for  the  installments  paid  are  surrendered  in 
exchange  for  regular  stock  certificates,  the  par  value 
should  be  included  under  the  appropriate  subdivision 
of  account  No.  25,  "Capital  Stock."  The  premium, 
if  any,  realized  on  such  capital  stock  should  be  dis- 
posed of  as  provided  in  the  text  of  account  No.  28, 
"Premium  Realized  on  Capital  Stock  Sold,"  while 
the  discount,  if  any,  should  be  disposed  of  as  pro- 
vided in  the  text  of  account  No.  18a,  "Discount  on 
Stock." 

27.  Stock  Liability  for  Conversion  of  Outstanding 

Securities  of  Constituent  Companies. 
This  account  should  include  the  company's  liabil- 
ity under  agreements  to  exchange  its  capital  stock 
for  the  outstanding  securities  of  constituent  com- 
panies whose  physical  property  has  been  acquired 
under  such  agreements,  but  whose  securities  have 
not  yet  been  surrendered  for  exchange. 

28.  Premium  Realized  on  Capital  Stock  Sold. 
When  stocks,  included  in  account  No.  25,  "Capital 

Stock,"  at  their  par  value,  are  issued  or  sold  at  a 
premium,  the  premium  realized  should  be  reported 
in  this  account  and,  if  the  stock  is  not  to  be  retired 
or  converted,  carried  on  the  balance  sheet  perma- 
nently or  until  extinguished  by  discounts  on  subse- 
quent sales  of  the  same  class  of  stock.    If  the  stock 


484  A  RAILWAY  BALANCE  SHEET 

is  to  be  retired  or  converted,  the  premium  should 
be  either  credited  to  Profit  and  Loss  or  against  the 
discount,  if  any,  suffered  at  the  date  of  such  retire- 
ment or  conversion. 

If  the  discount  in  account  No.  18a,  ^'Discount  on 
Stock, ' '  is  less  in  amount  than  the  premium  included 
in  this  account,  it  should  be  deducted  herefrom  and 
the  net  amount  included  in  this  account.  If  the  dis- 
count in  account  No.  18a  is  greater  than  the  premium 
credited  in  this  account,  the  premium  should  be  de- 
ducted therefrom  and  the  difference  included  in  ac- 
count No.  18a. 
Mortgage,  Bonded,  and  Secured  Debt. 
29.  Funded  Debt. 

There  should  be  entered  in  this  account  the  full 
amount  of  funded  debt  issued  by  the  respondent 
company  and  outstanding,  or  issued  by  other  com- 
panies and  outstanding  when  the  payment  of  such 
securities  has  been  assumed  by  the  respondent  com- 
pany, whether  all  or  any  portion  of  said  funded  debt 
is  held  by  the  public,  by  other  railway  companies, 
in  the  company's  treasury,  pledged  or  unpledged, 
held  uncanceled  by  the  trustees  of  sinking  funds  to 
retire  outstanding  obligations  issued  or  assumed  by 
the  respondent  company,  or  held  by  the  trustees  of 
any  other  special  funds  created  for  the  benefit  of 
the  respondent  company. 

The  amounts  included  in  this  account  should  be 
subdivided  as  follows: 

(a)  Mortgage  Bonds. — Bonds  secured  by  a  lien  on 
the  property  of  the  company,  except  as  provided  in 
the  other  subdivisions  of  this  account. 

(b)  Collateral  Trust  Bonds. — Bonds  secured  by; 
lien  on  securities  or  other  commercial  paper.  Stock 
trust  certificates  that  are  similar  in  character  to  col- 
lateral trust  bonds  should  be  included  under  this 


A  RAILWAY  BALANCE  SHEET  485 

heading,  as  should  also  short-time  collateral  trust 
notes. 

(c)  Plain  Bonds,  Debentures,  and  Notes. — Unse- 
cured certificates  of  indebtedness.  Short-time  notes 
(having  a  life  of  one  year  or  less)  given  in  payment 
of  temporary  indebtedness  should  not  be  included 
under  this  heading.  Short-time  notes  secured  by  col- 
lateral should  be  classed  with  collateral  trust  bonds. 
Debentures  should  be  clearly  distinguished  from  de- 
benture stock. 

(d)  Income  Bonds.— Bonds  which  are  a  lien  on  a 
carrier's  revenue  alone,  or  bonds  which,  while  being 
a  lien  on  its  road  and  franchises,  can  claim  payment 
of  interest  only  in  case  interest  is  earned. 

(e)  Equipment  Trust  Obligations. — Equipment 
bonds,  equipment  notes,  or  car  trust  notes  secured 
by  a  lien  on  specific  equipmeAt,  such  lien  having  been 
created  in  connection  with  the  acquisition  of  the 
equipment  securing  the  obligation. 

(f )  Miscellaneous  Funded  Obligations. — All  other 
funded  obligations  not  provided  for  by  the  other  sub- 
divisions of  this  account,  including  real-estate  mort- 
gages executed  or  assumed  by  a  carrier,  and  other 
similar  obligations. 

Note  A. — Bonds  are  considered  "issued"  when  they  are 
certified  by  trustees  and  placed  with  the  proper  officer  for  sale 
and  delivery.  "Outstanding  bonds"  include  all  bonds  issued  and 
not  canceled. 

Note  B. — This  account  is  not  intended  to  cover  securities 
when  the  payment  of  either  principal  or  interest  has  been 
guaranteed  only, 

30.  Receipts  Outstanding  for  Funded  Debt. 

When  funded  debt  is  sold,  to  be  paid  for  in  install- 
ments, the  amounts  received  in  such  installments 
should  be  included  in  ^this  account.  Upon  final  pay- 
ment of  purchase  price  and  the  surrender  of  receipts 
given  for  the  installments  paid  in  exchange  for  the 
regular  securities,  the  par  value  of  the  funded  debt 


486  A  RAILWAY  BALANCE  SHEET 

so  issued  should  be  transferred  to  the  proper  sub- 
division of  account  No.  29,  ''Funded  Debt."  The 
premium  realized,  if  any,  should  be  disposed  of  as 
provided  in  the  text  of  account  No.  31,  "Premium 
Realized  on  Funded  Debt  Sold,"  while  the  discount, 
if  any,  should  be  disposed  of  as  provided  in  the  text 
of  account  No.  18b,  "Discount  on  Funded  Debt." 

31.  Premium  Realized  on  Funded  Debt  Sold. 
When  bonds  are  issued  or  sold  at  a  premium,  they 

should  be  included  under  account  No.  29,  "Funded 
Debt,"  at  their  par  value.  The  premium  should  be 
credited  to  Income  in  such  equal  annual  installments 
during  the  life  of  the  bond  as  will  extinguish  the 
premium.  A  carrier  may,  however,  at  its  option, 
credit  to  Profit  and  Loss  such  premium  or  any  part 
of  it  at  any  time  unextinguished;  but  the  credit  to 
Income  in  any  one  year  must  not  exceed  the  amount 
of  the  annual  installment  applicable  to  that  period. 
The  premium  remaining  unextinguished  should  be 
reporjted  in  this  account. 

If  the  discount  in  account  No.  18b,  "Discount  on 
'Funded  Debt,"  is  less  in  amount  than  the  premium 
included  in  this  account,  it  should  be  deducted  here- 
from and  the  neit  amount  included  in  this  account. 
If  the  discount  in  account  No.  18b  is  greater  than 
the  premium  credited  in  this  account,  the  premium 
should  be  deducted  from  the  discount  and  the  differ- 
ence included  in  account  No.  18b. 

32.  Receivers'  Certificates. 

This  account  should  include  the  par  value  of  out- 
standing certificates,  notes,  or  other  obligations 
issued  by  receivers  in  charge  of  and  operating  the 
property  of  a  carrier,  and  the  par  value  of  certifi- 
cates, notes,  or  other  obligations  issued  by  receivers 
and  assumed  upon  reorganization. 


A  RAILWAY  BALANCE  SHEET  487 

33.  Obligations  for  Advances  Received  for  Construc- 

tion, Equipment,  and  Betterments. 
Proprietary,  affiliated,  and  controlled  companies 
should  show  in  this  account  the  amounts  advanced 
to  them  for  construction,  equipment,  and  additions 
and  betteraients  expenditures.  These  amounts,  if  ad- 
vanced by  another  carrier,  should  be  reported  by  it 
in  account  No.  5,  "Advances  to  Proprietary,  Affili- 
ated, and  Controlled  Companies  for  Construction, 
Equipment,  and  Betterments." 
Working  Liabilities. 

34.  Loans  and  Bills  Payable. 

This  account  should  include  the  balances  repre- 
senting obligations  outsitanding  in  the  form  of  loans 
and  bills  payable  or  other  similar  evidences  of  money 
borrowed,  payable  on  demand  or  within  a  time  not 
exceeding  one  year,  which  are  not  properly  classed 
under  account  No.  29,  "Funded  Debt." 

35.  Net  Traffic,  Car  Mileage,  and  Per  Diem  Balance. 
This  account  should  include  the  net  amounts  due 

to  other  companies  on  account  of  interline  freight 
and  ticket  balances  and  balances  resulting  from 
interchange  of  cars  on  a  per  diem  or  a  mileage  basis. 
Amounts  due  to  the  owners  of  private  cars  for  per 
diem  or  mileage  on  cars  should  be  considered  the 
same  as  amounts  due  to  other  railway  companies. 

36.  Audited  Vouchers  and  Wages  Unpaid. 

This  account  should  include  the  amount  of  audited 
vouchers  or  accounts  and  audited  pay-rolls  unpaid 
on  the  date  of  the  balance  sheet.  It  should  include 
unclaimed  wages  and  outstanding  pay  and  time  or 
discharge  checks  issued  in  payment  of  wages. 

37.  Miscellaneous  Accounts  Payable. 

There  should  be  included  in  this  account  unpaid 
and  outstanding  drafts  drawn  by  station  agents,  un- 
paid and  outstanding  drafts  drawn  on  the  company 


488  A  RAILWAY  BALANCE  SHEET 

in  settlement  of  freight  claims,  conductors'  rebate 
and  extra-fare  checks  not  presented  for  redemption, 
meal  checks  and  tickets  ouitstanding,  deposits  of  con- 
trolled companies,  and  other  items  of  the  nature  of 
demand  liabilities  not  covered  by  accounts  Nos.  34, 
35,  36,  38,  and  39. 

Note. — The  amount  to  be  reported  under  this  account  is  not 
the  net  balance  between  accounts  Nos.  12  and  37. 

38.  Matured  Dividends,  Interest,  and  Rents  Unpaid. 
This  account  should  include  the  amount  of  divi- 
dends payable  on  capital  stock  and  unpaid,  uncalled 
for,  or  unclaimed  at  the  date  of  the  balance  sheet. 
Including  dividends  payable  on  the  first  day  of  the 
month  following  that  for  which  the  balance  sheet 
is  made ;  the  amount  of  matured  and  unpaid  interest 
on  the  funded  debt  of  the  respondent  company, 
and  of  other  companies  when  payment  has  been  as- 
sumed by  the  respondent  company,  including  inter- 
est which  matures  on  the  first  day  of  the  month  fol- 
lowing that  for  which  the  balance  sheet  is  made; 
unpaid  dividends  on  the  stock  and  unpaid  interest 
on  the  funded  debt  of  other  companies  when  same 
are  payable  by  the  respondent  company  as  all  or  a 
portion  of  the  rent  due  under  leases;  and  all  other 
rents  due  under  leases  which  have  become  payable. 

39.  Matured  Mortgage,  Bonded,  and  Secured  Debt 

Unpaid. 
This  account  should  include  the  amount  of  ma- 
tured mortgage,  bonded,  and  secured  debt  payable 
but  not  yet  paid,  including  bonds  drawn  for  redemp- 
tion through  the  operation  of  sinking  and  redemp- 
jtion  fund  agreements.  Obligations  which  mature  on 
the  first  day  of  the  month  following  that  for  which 
the  balance  sheet  is  made  should  be  included  in  this 
account. 

40.  Working  Advances  Due  to  Other  Companies, 


A  RAILWAY  BALANCE  SHEET  489 

Proprietary,  affiliated,  and  controlled  companies 
should  include  in  this  account  the  amounts  advanced 
to  them  for  general  purposes,  such  as  advances  to 
pay  interest  on  their  funded  debt  not  included  in 
account  No.  33,  **  Obligations  for  Advances  Eeceived 
for  Construction,  Equipment,  and  Betterments,"  def- 
icits resulting  from  their  operation,  and  advances 
for  construction,  equipment,  and  additions  and  bet- 
terments, when  such  advances  are  made  under  the 
conditions  Sitated  in  account  No.  15a,  ^'Advances  to 
Proprietary,  Affiliated,  and  Controlled  Companies," 
and  when  that  account  is  used  to  report  the  advances 
by  the  company  making  them. 

41.  Other  Working  Liabilities. 

This  account  should  include  items  of  worldng  lia- 
bilities not  covered  by  accounts  Nos.  34  to  40,  in- 
clusive. It  should  include  liability  items  that  have 
not  reached  the  stage  of  audited  liabilities  and  be- 
come actually  payable,  yet  are  obligations  of  the 
company  and  advanced  beyond  the  stage  of  accounts 
properly  classed  under  account  No.  46,  ''Items  in 
Suspense,"  such  as  retained  percentages  due  con- 
tractors to  be  paid  on  completion  of  contracts;  de- 
posits for  construction  of  side  tracks,  to  be  refunded 
on  the  basis  of  an  agreed  percentage  of  the  earnings 
from  the  traffic  handled  over  the  tracks;  prepaid 
charges  billed  out  on  waybills  not  taken  into  the 
month's  accounts ;  and  other  similar  items.  It  should 
include  also  balances  to  the  credit  of  employes'  sav- 
ings funds,  and  relief,  hospital,  and  other  association 
funds  when  such  funds  are  held  unidentified  in  the 
carrier's  treasury  and  are  included  in  account  No.  7, 
''Cash." 
Accrued  Liabilities  Not  Due. 

42.  Dividends  Declared  and  Interest  and  Rents  Ac- 

crued, Not  Due. 


490  A  RAILWAY  BALANCE  SHEET 

This  account  should  include  the  amount  of  divi- 
dends on  capital  stock,  interest  on  funded  debt,  in- 
cluding interest  on  funded  debt  assumed,  and  rents 
under  leases,  accrued  to  the  date  for  which  the  bal- 
ance sheet  is  made  but  not  payable  until  after  the 
first  day  of  the  following  month.  There  should  be 
included  also  as  ''rents  accrued"  the  amount  of  ac- 
crued dividends  on  the  stock  and  accrued  interest 
on  the  funded  debt  of  other  companies  when  such 
dividends  and  interest  are  paid  as  all  or  a  portion  of 
the  rent  under  leases  from  those  companies. 

43.  Taxes  Accrued. 

This  account  should  include  the  amount  of  taxes 
accrued  and  charged  against  income  in  excess  of  the 
amount  paid.  When  the  respondent  company  leases 
the  property  of  another  company  and,  under  the 
terms  of  the  lease,  agrees  to  pay  or  assume  the  taxes 
that  may  be  levied  upon  or  assessed  against  such 
property,  the  taxes  accrued  on  such  property  should 
be  included  in  this  account  and  not  in  account  No.  42. 
"When,  however,  the  taxes  are  paid  by  the  lessor 
company,  the  full  amount  of  cash  rent  to  be  paid  by 
the  lessee  should  be  included  in  account  No.  42. 
Deferred  Credit  Items. 

44.  Operating  Reserves. 

This  account  should  include  the  ledger  balances  in 
the  reserves  created  to  cover  past  depreciation  of 
property;  reserves  created  since  July  1,  1907,  by 
charges  to  Operating  Expenses  to  cover  accrued  de- 
preciation of  equipment  and  of  way  and  structures 
when  a  plan  for  such  purpose  has  been  adopted  by 
the  carrier;  reserves  created  by  charges  to  Operating 
Eevenues  or  to  Operating  Expenses  to  provide  for 
overcharge,  personal  injury,  insurance,  and  other 
claims ;  and  similar  reserves.  The  credits  in  this  ac- 
count should  be  subdivided  as  follows: 


A  RAILWAY  BALANCE  SHEET  491 

Xa)'  Reserves  for  Replacemen(t  of  Property. 

(b)  Reserves  for  Other  Purposes. 

The  credit  balance  in  sinking  fund  reserve  ac- 
count should  not  be  included  in  this  account.  See 
account  No.  47a,  ^^  Reserves  Invested  in  Sinking  and 
Redemption  Funds.'' 

45.  Liability  on  Account  of  Special  Trust  Funds. 
This  account  should  include  the  ledger  balances 

covering  the  amount  of  cash  and  the  cost  of  securi- 
ities  in  the  hands  of  trustees  or  managers  of  employes ' 
savings  funds,  relief,  hospital,  and  other  association 
funds,  when  such  trustees  or  managers  are  acting 
for  the  carrier  in  the  administration  of  such  funds. 
The  amount  reported  in  this  account  should  agree 
with  the  amount  reported  in  account  No.  22,  ''Cash 
and  Securities  in  Special  Trust  Funds." 

46.  Items  in  Suspense. 

Under  this  caption  should  be  included  suspense 
accounts  showing  credit  balances  that  cannot  be 
entirely  cleared  and  disposed  of  until  additional  in- 
formation is  received,  such  as  collections  by  general 
agents  and  others  to  cover  prepayment  of  shipments 
originating  on  lines  of  other  carriers;  amounts  real- 
ized from  sale  of  damaged,  unclaimed,  and  over 
freight  and  held  pending  claim;  switching  charges 
of  other  carriers  collected  and  held  awaiting  bills 
from  such  carriers;  amounts  received  from  sale  of 
mileage  tickets  to  be  disposed  of  as  mileage  is  hon- 
ored by  the  respondent  or  other  carriers;  amounts 
collected  for  milling-in-transit  privileges,  to  be 
cleared  when  products  are  shipped;  credit  balances 
in  ''Shop  Expense"  and  "Store  Expense"  accounts; 
and  other  similar  items. 
Appropriated  Surplus. 

47.  Surplus  Reserves. 

In  this  account  should  b'e  grouped  all  appropria- 


492  A  RAILWAY  BALANCE  SHEET 

tions  of  surplus  (except  as  covered  by  account 
No.  48),  including  imexpended  balances  of  appropri- 
ations for  additions  and  bcitterments.  The  account 
should  be  subdivided  under  the  following  heads : 

(a)  Reserves  Invested  in  Sinking  and  Redemption 
Funds. 

Amounts  charged  against  Income  Account  for 
sulking  fund  payments;  accretions  to  sinking  funds 
in  the  hands  of  trustees;  also  amounts  realized  and 
turned  over  to  sinking  fund  trustees  or  used  in  the 
purchase  of  outstanding  obligations  either  by  sink- 
ing fund  trustees  or  by  the  respondent  company, 
when  such  sums  are  realized  from  other  sources  than 
the  company's  income.  All  credits  to  this  account 
(to  cover  amounts  turned  over  to  sinking  fund  trust- 
tees,  and  all  accretions  to  sinking  funds  collected  by 
trustees,  should  be  debited  to  the  account  with  such 
trustees  in  account  No.  20. 

(b)  Reserves  Invested  in  Other  Special  Funds. 

(c)  Reserves  Not  Specifically  Invested. 

48.  Additions  to  Property  through  Income  since  June 

30,  1907. 
This  account  should  include  the  cost  of  property 
acquired  by  expenditures  of  appropriations  from 
Income  since  June  30,  1907,  whether  such  expendi- 
tures are  for  new  lines  or  for  additions  and  better- 
ments to  existing  lines.  The  amount  standing  to 
the  credit  of  this  account  should  be  included  in  th6 
amount  reported  under  account  No.  1-B,  **Road  and 
Equipment  since  June  30, 1907." 
Free  Surplus. 

49.  Profit  and  Loss — Balance. 

This  account  should  include  the  balance,  if  any, 
standing  to  the  credit  of  the  profit  and  loss  account. 

When  there  is  a  debit  balance  in  the  profit  and 
loss  account,  but  such  balance  does  not  exceed  the 


A  RAILWAY  BALANCE  SHEET  493 

total  credit  balance  of  accounts  Nos.  47  and  48,  the 
latter  are  to  be  stated  in  short  column,  the  toital 
brought  down,  and  the  debit  balance  of  account 
No.  49  deducted  therefrom,  the  difference  being  ex- 
tended to  the  total  column  as  the  net  appropriated 
surplus.  When  the  debit  balance  standing  in  ac- 
count No.  49  exceeds  the  total  credit  balance  of  ac- 
counts Nos.  47  and  48,  the  accounts  are  to  be  stated 
as  prescribed  in  the  text  of  account  No.  24. 


SECTION  G. 
THE  ACCOUNTS  OF  A  TELEPHONE  COMPANY.* 

I.   Objects  of  Accounting  Scheme. 

A  suitable  scheme  of  accounting  for  the  Bell  Tele- 
phone System  must  attain  these  objects. 

1.  It  must  be  uniform  in  its  essential  and  fundamental 
features  so  that  the  results  of  the  business  can  be  com- 
pared and  combined. 

2.  It  must  be  elastic  in  details  so  as  to  furnish  at  the  one 
extreme  the  simple  information  needed  with  respect  to 
the  numerous  small  exchanges  and  at  the  other  extreme 
the  great  and  complicated  variety  of  information  needed 
with  respect  to  a  large  city  system  with  every  degree 
of  greater  or  less  detail  for  the  conditions  between 
these  extremes. 

3.  It  must  be  sound  in  principle  so  as  to  meet  the  most  rigid 
scrutiny  of  investors  and  public  authorities. 

4.  It  must  conform  to  organization  so  as  to  associate  the 
strong  and  weak  spots  with  the  individuals  responsible 
for  them. 

5.  It  must  be  practicable  in  application,  speedy  in  opera- 
tion and  dependable  in  results. 

II.  Limitations. 

A  bare  statement  of  these  objects  to  be  obtained  sug- 
gests at  once  not  merely  the  difficulties  to  be  expected 
in  constructing  such  a  scheme  of  accounts  but  also  cer- 
tain natural  limitations  which  must  be  respected  or  the 
scheme  will  fall  of  its  own  weight.  A  brief  reference 
to  some  of  these  limitations  may  assist  in  the  general 
understanding  of  the  work  as  a  whole. 

1.   A  scheme  of  accounts  is  a  distribution  of  the  financial 


*  Reprinted  by  permission  of  Charles  G.  DuBois,  Comptroller  of  American 
Telephone  &  Telegraph  Company. 

494  _j 


TELEPHONE  COMPANY  ACCOUNTS         495 

transactions  of  tlie  business  into  classes,  and  attempts 
to  define  those  classes.  Now,  figures,  whether  accurate 
or  inaccurate,  are  from  their  nature  precise.  They  do 
not  qualify  themselves  nor  express  shades  of  meaning. 
Language  on  the  other  hand  as  commonly  used  is  not 
very  exact.  Words  that  are  equivalent  in  one  connec- 
tion express  shades  of  meaning  or  even  different  mean- 
ings when  used  in  another  connection.  Even  technical 
accounting  terms  have  not  yet  come  to  have  exact  and 
authoritative  meanings  and  even  though  accounting 
terms  be  arbitrarily  defined  for  our  use,  the  definitions 
of  classes  of  transactions  must  further  be  expressed  in 
words  and  phrases  which  can  be  understood,  not  only 
by  telephone  men  but  generally  by  men  accustomed  to 
considering  any  business  transactions. 

It  follows  that  definitions,  whether  in  general  or 
technical  language,  will  not  always  convey  exactly  the 
same  meanings  to  all  the  people  who  may  use  them. 

Every  financial  transaction  has  to  go  through  the 
books  and  its  classification  has  to  be  decided.  Such 
transactions,  as  do  not  clearly  fall  under  some  one  defini- 
tion, have  therefore  to  be  specially  adjudicated. 

An  accounting  scheme,  as  laid  down  in  our  account- 
ing  circular,  forms   only  the  nucleus   or  foundation 
around  which  must  be  gathered  interpretations  and  de- 
cisions on  many  specific  cases,  which  decisions  come  in 
time  to  be  a  part  of  the  accounting  scheme. 
2.    Changes  in  operating  conditions  increase  the  difficulty 
of  uniformity.     Sometimes,  for  instance,  it  appears 
more  important  to  make  the  accounting  for  a  certain 
kind  of  transactions  conform  to  the  organization  than 
to  have  it  uniform  in  different  organizations,  though  in 
general  I  believe  uniformity  is  the  paramount  object  to 
be  sought. 
^.  Comparisons  of  present  periods  with  previous  periods 
are  important  as  a  guide  to  the  changes  in  results  which 


496         TELEPHONE  COMPANY  ACCOUNTS 

are  taking  place,  but  too  rigid  adherence  to  this  prin- 
ciple would  mean  that  the  accounting  could  not  be  de- 
veloped to  keep  pace  with  the  business. 

4.  The  indirect  relations  of  things,  which  as  already  sug- 
gested can  only  be  imperfectly  expressed  in  figures,  are 
always  likely  to  be  under-estimated  or  misinterpreted 
from  a  superficial  study  of  financial  reports,  and  this 
is  particularly  true  of  figures  for  geographical  areas, 
in  the  telephone  business  where  every  local  area  is  con- 
nected with  every  other. 

5.  In  taking  up  one  after  another  the  various  transactions 
in  the  telephone  business,  it  may  seem  as  if  each  one 
were  sufficiently  important  to  warrant  its  inclusion  in 
the  accoimting  sj^stem,  but  when  these  are  all  listed 
it  will  appear  that  the  variety  of  information  is  too 
great  for  any  one  administrative  officer  to  consider  and 
understand  from  month  to  month,  or  that  if  he  does 
so  he  thereby  loses  a  grasp  on  the  results  as  a  whole. 

While  the  true  remedy  for  this  lies  largely  in  the 
perfection  of  organization  with  a  view  to  pushing  infor- 
mation and  authority  further  and  further  down  the  line, 
yet  the  elaboration  of  accounts  on  such  lines  can  only 
gradually  be  justified  as  this  administrative  process 
goes  gradually  on. 

6.  Other  limitations  relate  to  the  mechanics  of  bookkeep- 
ing and  the  limited  clerical  facility  of  people  in  the  field 
dealing  with  the  primary  transactions.  I  hold  that  a 
very  high  degree  of  clerical  accuracy  can  be  attained 
in  the  field  without  difficulty  or  increased  expense,  pro- 
vided the  classes  of  transactions  with  which  any  one 
employe  deals  are  few  in  number  and  are  defined  in 
the  language  to  which  he  is  accustomed.  This  is  none 
the  less  a  real  limitation  to  the  logical  development 
of  accounts. 


TELEPHONE  COMPANY  ACCOUNTS         497 

III.  Method  of  Constructing  Scheme  of  Accounts. 

All  of  this  means  of  course  that  we  have  had  to  deal 
with  the  problem  without  forgetting  on  the  one  hand  the 
objects  to  be  attained,  and  on  the  other  the  dangers  to  be 
avoided  and  the  limitations  to  be  respected. 

There  was  a  respectable  amount  of  information  to  serve 
as  a  guide  in  constructing  our  scheme  of  accounts.  In  the 
first  place  we  had  the  present  scheme  of  accounts  generally 
followed  by  the  Telephone  Companies.  This  represents  a 
gradual  development  of  such  accounts  as  were  shown  by 
experience  to  be  particularly  useful.  It  has  few,  if  any, 
faults  that  could  be  called  fundamental.  The  chief  criti- 
cism has  been  that  it  lacked  adaptation  to  administrative 
purposes.  The  natural  course  then  was  to  get  the  consen- 
sus of  opinion  of  telephone  men  generally  as  to  the  re- 
vision and  amplification  of  the  present  scheme.  For  this 
purpose  the  advice  of  Engineers,  Accountants  and  Plant, 
Traffic,  Commercial  and  Administrative  Officers  in  all 
parts  of  the  country  was  sought  on  the  various  phases  of 
the  work  with  which  they  were  most  familiar.  Confer- 
ences were  held  and  reports,  suggestions  and  data  were 
gathered.  The  work  along  similar  lines  attempted  by 
other  public  service  corporations  was  reviewed  and  in  this 
connection  the  comprehensive  and  admirable  scheme  of 
railway  accounts  established  by  the  Interstate  Commerce 
Commission  was  found  particularly  useful.  At  the  same 
time  the  various  text-books  on  accounts  particularly  those 
relating  to  modem  accounting  principles  and  practice  were 
consulted.  After  all  this  preliminary  work  a  first  draft 
of  our  proposed  scheme  was  prepared  and  submitted  gen- 
erally to  Bell  Telephone  Officials  throughout  the  country 
for  comment  and  criticism.  As  these  comments  and  criti- 
cisms were  received  they  were  sifted  and  discussed,  as  a 
result  of  which  the  scheme  was  several  times  revised  and 

B— VIII— 32 


498         TELEPHONE  COMPANY  ACCOUNTS 

finally  the  last  revision  was  issued  as  Accounting  Circu- 
lar No.  6. 

IV.  Scope  of  Accounting  Circular  No.  6. 

This  circular  brings  together  in  one  publication  our 
present  judgment  as  to  the  accounts  needed  by  a  telephone 
company  with  the  definitions  of  those  accounts. 

It  may  be  readily  adapted  to  the  use  of  small  sub- 
licensees and  connecting  companies  by  using  generally  the 
main  accounts  (which  are  printed  in  black  faced  type)  per- 
haps substituting  for  Commercial  and  Traffic  Expenses  and 
to  some  extent  for  General  Expenses  the  corresponding 
sub-accounts  given  under  the  clearing  account  Non-Func- 
tional Exchange  Expenses.  This  would  depend  on  the  or- 
ganization of  the  company  in  question. 

The  sub-accounts,  many  of  which  are  optional,  give  the 
information  needed  by  larger  companies  of  various  sizes 
and  conditions  up  to  the  largest  and  most  complicated, 
while  still  more  detailed  information  may  be  obtained  by 
the  use  of  any  additional  sub-accounts  that  may  be  desired 
for  special  needs. 

An  important  feature  of  the  scheme  is  the  code  num- 
bers provided  for  all  accounts  and  the  method  provided 
for  getting  statistical  information  by  divisions,  districts 
or  even  exchanges  should  it  be  desired.  The  extent  to 
which  this  is  to  be  carried  is  simply  a  question  of  the  ex- 
pense of  the  clerical  work  compared  with  the  value  of  the 
information  at  any  time  or  place. 

In  the  following  discussion  of  the  accounts  I  shall  so 
far  as  possible,  even  at  the  risk  of  some  crudeness,  endeavor 
to  avoid  the  use  of  technical  accounting  language  or  when 
using  such  expressions,  will  try  to  explain  them  as  I  go 
along. 

Any  scheme  of  accounts  must  deal  with  four  main 
groups,  viz.: — the  Assets,  the  Liabilities,  the  Revenue  and 
the  Expenses. 


TELEPHONE  COMPANY  ACCOUNTS         499 

By  assets  at  any  date  we  mean  generally  the  property  ex- 
isting at  that  date. 
By  liabilities  at  any  date  we  mean  generally  the  debts  ow- 
ing at  that  date  including  the  company's  obligations 
to  its  stockholders  for  their  respective  shares  in  the 
business. 
By  revenue  for  any  period  we  mean  generally  what  the 
company  has  received  or  is  entitled  to  receive  for  its 
services  during  that  period. 
By  expenses  for  any  period  we  mean  generally  the  cost 
to  the  company  of  conducting  its  business  for  that 
period. 

The  asset  or  property  accounts  and  the  expenses 
always  appear  as  debit  or  charge  accounts  on  the  books. 
The  liabilities  and  'the  earnings  always  appear  as 
credit  accounts  on  the  books. 

The  distinction  between  assets  and  expenses  (both 
being  debit  accounts)  though  easy  to  define  is  not  always 
easy  to  maintain  in  practice.  It  is  of  vital  consequence 
however  since  the  net  results  of  the  business  for  any  period 
cannot  otherwise  be  known  and  the  attention  of  accountants 
is  largely  directed  to  safeguarding  this  point.  The  familiar 
form  which  confusion  on  this  distinction  takes  is  reflected 
in  the  expression  ''Construction  has  been  charged  items 
that  ought  to  have  gone  to  Maintenance"  or  vice  versa. 

V.   Plant. 

The  preponderant  property  of  an  operating  tele- 
phone company  is  of  course  that  known  as  Plant  or 
Construction. 
1.   Value  at  which  Property  is  Carried. 

Before  taking  up  the  various  classes  of  Plant  it  is 
worth  while  to  consider  the  proper  basis  for  the  figures 
carried  on  the  books  to  represent  the  value  of  this  and 
other  property. 

It  may  be  said  that  theoretically  property  accounts 


500         TELEPHONE  COMPANY  ACCOUNTS 

should  show  what  it  would  cost  to  replace  the  property 
with  equivalent  new  property  and  that  against  this 
should  be  carried  contra  or  liability  accounts  for  the 
deterioration  that  has  taken  place,  the  difference  be- 
tween the  two  accurately  representing  the  present  value 
of  the  property.  In  practice  this  is  not  feasible  nor 
altogether  desirable;  first,  because  to  determine  it  would 
call  for  frequent  inventories  the  expense  of  which  as 
respects  plant  would  be  prohibitive;  second,  the  de- 
terioration that  has  taken  place  is,  as  anyone  can  readily 
see,  impossible  of  any  accurate  determination;  and 
third,  it  is  advantageous  to  know  currently  what  plant 
has  cost  rather  than  what  it  would  now  cost.  The  prac- 
tical procedure  is  to  exercise  great  care  in  making  addi- 
tions to  plant  accounts  at  the  true  cost  of  such  addi- 
tions, verifying  this  by  inventory  at  intervals  of  several 
years.  On  the  other  hand  provision  should  be  made 
out  of  earnings  to  represent  depreciation  as  it  takes 
place  as  nearly  as  this  can  be  estimated,  this  provision 
being  set  aside  or  reserved  to  be  used  for  future  re- 
placement. An  estimate  of  depreciation  is  properly 
based  on  the  probable  life  of  different  classes  of  plant, 
allowing  for  the  net  value  of  the  salvage  expected  to  be 
recovered.  Unfortunately  the  data  on  which  such  esti- 
mates can  be  based  is  still  incomplete,  chiefly  because 
some  classes  of  plant  of  the  general  character  now  in 
use  have  not  yet  shown  in  experience  their  probable 
age  limits. 

The  study  of  depreciation  is  of  itself  almost  a  life 
work  and  one  of  the  most  profound  importance,  for 
whether  a  telephone  company  is  making  or  losing  money 
may  depend  solely  on  the  rate  of  depreciation.  Our 
scheme  of  accounts  is  now  arranged  so  as  to  provide 
accurate  statistics  as  to  what  plant  is  actually  being 
built  and  replaced,  so  that  in  a  few  years  we  shall  have 
valuable  data  on  the  various  doubtful  points.    In  the 


TELEPHONE  COMPANY  ACCOUNTS         501 

meantime  we  aim  to  follow  the  best  information  we 
now  have  or  can  get  as  reflected  in  the  opinions  of  those 
who  have  had  most  experience  with  the  subject. 

The  true  cost  of  additions  to  plant  is  somewhat  diffi- 
cult to  ascertain  because  the  construction  of  new  and 
the  removal  of  old  plant  are  continuous  processes  to 
which  nearly  every  department  lends  a  hand,  but  we 
are  satisfied  that  reasonable  accuracy  can  be  attained 
by  the  methods  provided. 
2.    General  Classes  of  Plant. 

The  Bell  Companies  have  for  many  years  followed 
the  practice  of  building  their  own  plants  and  of  classi- 
fying them  so  as  to  show  the  cost  of  the  different  classes. 
In  Accounting  Circular  No.  6  we  retain  the  classes  that 
have  come  to  have  a  definite  meaning  to  many  people 
both  in  and  out  of  the  business  but  we  now  group  these 
classes  somewhat  differently  than  heretofore. 

After  considering  the  subject  from  various  stand- 
points it  seems  to  us  that  there  are  four  general  classes 
of  plant — 

Real  Estate, 
Equipment, 
Exchange  Lines, 
Toll  Lines. 
5.   Real  Estate. 

Real  Estate  is  easily  distinguished  from  other  plant, 
it  usually  has  a  separate  taxation  status,  it  is  the  basis 
for  computing  rent  charges,  and  it  seems  for  these 
reasons  desirable  to  keep  it  in  a  separate  account. 
4.   Equipment. 

Equipment  is  distinguished  from  Exchange  Lines 
and  Toll  Lines  because  of  its  character  as  reflected  in 
the  common  expressions  "inside  plant"  and  '* outside 
plant." 

Under  Equipment  there  are  two  great  classes: — 
Central  Offices  and  Subscribers'  Stations,  between  which 


502         TELEPHONE  COMPANY  ACCOUNTS 

there  is  an  important  distinction  not  only  in  location 
but  in  permanence  of  location. 

The  station  appartus  is  constantly  moving  from  one 
place  to  another.  This  constitutes  a  heavy  burden  on 
the  telephone  business,  but  it  is  one  of  the  things  that 
makes  the  service  valuable.  It  is  worth  something  to 
every  telephone  patron  to  know  that  when  he  or  other 
patrons  move  from  one  residence  or  office  to  another 
their  telephone  service  is  not  discontinued.  The  con- 
stant shifting  of  industry  and  residence  and  the  tear- 
ing down  and  rebuilding  going  on  in  our  cities  is  fre- 
quently remarked  but  the  public  is  so  habituated  to 
the  convenience  of  having  terminal  telephones  imme- 
diately provided  to  keep  up  with  this  shifting  that  its 
value  is  seldom  considered.  But  a  little  reflection  shows 
its  great  value  not  only  to  the  subscriber  who  moves 
but  perhaps  even  more  to  all  the  subscribers  who  may 
want  to  communicate  with  him. 

Eoughly  of  every  five  stations  in  service  at  the  be- 
ginning of  a  year  one  goes  out  of  seTOce  during  the 
year,  or  in  other  words  the  average  period  a  station 
remains  in  service  is  about  five  years.  Even  this  does 
not  include  moving  the  station  from  one  location  to 
another  for  the  same  subscriber  nor  changing  the  sub- 
scriber without  moving  the  station.  While  this  station 
shifting  usually  does  not  much  affect  the  number  con- 
nected to  one  exchange  and  so  does  not  throw  out  of 
service  much  of  the  exchange  lines  or  central  office' 
equipment  it  considerably  a:ffccts  the  wires  connecting 
the  station  to  the  exchange  lines,  commonly  called  drop 
wires  or  interior  block  wires  which  for  this  reason  are 
included  with  subscribers'  station  equipment  in  the 
accounts. 

The  value  and  practicability  of  sub-accounts  under 
central  office  equipment  and  subscribers'  station  equip- 
ment will  vary  with  the  conditions.     All  such  sub- 


TELEPHONE  COMPANY  ACCOUNTS         503 

accounts  are  therefore  made  optional  but  these  optional 
sub-accounts,  like  others,  point  the  way  I  think  to  the 
kinds  of  information  that  are  more  and  more  likely  to 
be  found  useful.  For  instance  in  studying  the  expense 
caused  by  shifting  of  stations  it  will  be  of  great  assis- 
tance to  know  how  much  of  that  plant  is  the  set  (which 
is  recovered)  how  much  the  cost  of  installation  and  in- 
side wires  (on  which  there  is  little  recovery)  and  how 
much  the  cost  of  drop  wires  (on  which  the  chances  of 
recovery  greatly  vary  though  the  recover  if  made  is 
likely  to  be  complete). 

5.  Outside  Plant. 

In  considering  the  outside  plant  the  most  important 
distinction,  that  between  Aerial  and  Underground,  indi- 
cates the  character  and  development  of  the  plant,  its 
degree  of  permanence,  and  has  much  significance  when 
comparing  original  cost  and  cost  of  repair. 

6.  Distinctions  Between  Exchange  and  Toll  Plant. 

While  this  distinction  and  others  have  become  com- 
monly accepted  as  important  in  the  business  other  dis- 
tinctions once  of  great  significance  have,  in  some  locali- 
ties, lost  some  of  their  force. 

■For  instance  the  distinction  between  exchange  lines 
and  toll  lines  in  the  complicated  systems  centering  at 
the  very  large  cities  is  difficult  in  practice,  though  in 
the  country  as  a  whole  it  i)ossesses  as  great  importance 
as  ever. 

The  question  is  raised  why  it  is  worth  while  to  con- 
tinue this  distinction  between  exchange  and  toU  lines, 
since  even  though  the  lines  can  be  divided,  no  practi- 
cal accounting  methods  are  known  by  which  the  entire 
central  office  equipment  and  subscribers'  station  equip- 
ment can  be  divided  between  exchange  and  toll.  With- 
out rehearsing  the  detail  of  the  argument  on  both  sides 
of  this  interesting  question,  it  is  worth  while  to  indi- 
cate here  the  reasons  for  the  conclusions  reached. 


504         TELEPHONE  COMPANY  ACCOUNTS 

In  the  first  place,  the  distinction  between  excliange 
and  toll  business  has  been  observed  from  the  beginning 
and  is  still  observed  in  making  rates.  Every  rate 
scheme  seems  to  be  based,  and  soundly  so,  on  the  princi- 
ple that  the  subscribers'  station,  the  line  from  the  sta- 
tion to  the  central  office,  the  bulk  of  the  central  office 
equipment,  and  finally  the  trunks  connecting  central 
offices  are  built  primarily  for  the  purpose  of  transmit- 
ting local  or  exchange  messages.  Each  line  is  thus 
mainly  built  and  held  ready  for  the  subscriber's  par- 
ticular use.  On  all  the  plant  just  enumerated  the  sub- 
scriber undertakes  for  a  stated  period,  usually  one  year, 
to  pay  for  his  exclusive  service  and  a  fair  return  on 
the  investment  held  for  his  exclusive  use.  For  a  toll 
line  however  the  subscriber  commits  himself  to  nothing. 
It  is  built  entirely  at  the  company's  risk,  and  it  is  very 
difficult  to  forecast  accurately  what  business  can  be  ex- 
pected for  a  new  line,  while  the  volume  of  business  even 
on  long  established  lines  fluctuates  considerably. 

It  seems  wise  therefore  to  know  the  revenue  from 
such  business  and  the  cost  of  the  lines  that  carry  it, 
even  though  it  is  difficult  in  certain  cases  to  apply  the 
distinctions  and  even  though  it  is  impossible  to  dis- 
tinguish the  expenses  applying  to  the  exchange  and  the 
toll  service. 
7.    Eeasons  for  Classifying  Plant. 

The  reasons  for  classifying  plant  may  be  thus 
summarized: 

(a)  It  is  important  to  be  able  to  analyze  the  invest- 
ment in  plant  so  as  to  help  guard  against  includ- 
ing anything  therein  which  should  go  to  expense. 

(b)  The  proper  treatment  of  the  station  moves  would 
be  impracticable  if  station  plant  were  not  kept 
distinct. 

(c)  No  one  unit  suffices  for  a  comparison  of  one  plant 
with  another,  because  one  plant  may  have  more 


TELEPHONE  COMPANY  ACCOUNTS         505 

underground  lines  or  more  toll  lines  than  another. 
(d)     The  analysis  of  certain  expenses,  for  instance  re- 
pairs, is  incomplete  without  knowledge  as  to  the 
cost  of  classes  of  plant, 
(e)'    Depreciation  can  be  estimated  more  closely  if  fig- 
ured by  classes  instead  of  at  an  average  rate  for 
the  whole. 
[(f)'    Any  study  of  earnings  and  of  rates,  which  are  the 
basis  of  earnings,  depends  largely  on  the  charac- 
ter of  the  plant. 
XgJ    The  character  and  cost  of  new  plant  are  guided 
somewhat  by  experience  with  previous  plant. 
If  these  reasons  are  convincing  the  question  natur- 
ally arises  and  has  been  asked  why  we  do  not  sub-divide 
plant  still  further  and  so  increase  the  advantages.    The 
answers  to  this  are,  first,  that  the  plant  already  built 
would  have  to  be  inventoried  or  appraised  at  once  to 
the  finer  sub-divisions,  and  second,  that  clerical  accu- 
racy in  the  field  becomes  more  difficult  with  every  addi- 
tional plant  account.     For  these  two  reasons  various 
proposals  to  extend  the  required  plant  classifications 
were  rejected  and  only  the  classes  heretofore  used  are 
to  be  required,  but  optional  sub-accounts  have  been  pro- 
vided for  most  of  the  finer  sub-divisions  proposed. 
8.   Plant  Measurements. 

A  subject  deserving  and  constantly  receiving  more 
attention  and  interest  may  be  briefly  referred  to  here 
under  the  term  Plant  Unit  Costs,  by  which  we  mean, 
for  instance,  the  cost  of  station  equipment  per  station, 
or  of  exchange  underground  plant  per  mile  of  wire, 
and  so  on.  The  importance  of  such  information  ap- 
pears when  we  compare  one  company  with  another  or 
study  the  effect  of  increasing  wages  and  costs  of  ma- 
terial. 

These  studies  lead  us  naturally  to  consider  how  the 
number  of  miles  of  wire,  number  of  stations  and  so  on 


506         TELEPHONE  COMPANY  ACCOUNTS 

are  being  ascertained.  At  first  thought  one  might  say 
that  there  could  hardly  be  two  opinions  as  to  what  con- 
stitutes a  mile  of  wire  or  a  station.  But  on  close  analysis 
we  find  we  must  define  the  point  at  which  a  wire  begins 
and  ends,  whether  at  the  entrance  to  a  building  or  at 
the  instrument,  whether  wire  mileage  includes  the  drop 
wire  or  not,  whether  it  includes  any  of  the  wiring  in 
the  distributing  frames  and  so  on.  Again  are  P.  B.  X. 
operators'  telephones  and  company  service  stations  to 
be  classed  as  stations  and  so  on? 

Again  in  attempting  to  define  a  mile  of  pole  line 
and  particularly  to  divide  it  between  toll  and  exchange 
when  it  may  carry  some  toll  wires  for  long  distances, 
varying  numbers  of  exchange  wires  for  varying  dis- 
tances and  perhaps  also  a  cable  or  two  containing  wires 
some  of  which  may  be  toll  one  month  and  exchange 

the  next,  we  have  serious  complications 

VI.  Working  Assets. 

The  next  general  class  of  property,  which  for  want  of 
a  better  name  may  be  called  Working  Assets,  comprises 
office  furniture  and  fixtures,  tools  and  vehicles  and  supplies. 
It  is  important  to  distinguish  these  three  classes  not 
only  so  as  to  watch  their  increase  more  carefully  but  also 
because  the  expenses  that  relate  to  them  take  different 
courses. 

It  is  better  to  carry  the  depreciation  reserve  for  these 
working  assets  in  offsetting  accoimts  rather  than  as  a  de- 
duction from  the  face  of  the  account.  The  face  value  can  be 
known  with  some  degree  of  accuracy,  while  the  net  value 
is,  like  depreciation,  a  matter  of  estimate.  In  Supplies 
it  is  not  practicable  to  take  material  returned  from  plant 
at  its  then  estimated  value  and  re-issue  it  at  that  value. 
The  practical  way  is  to  take  in  material  fit  for  re-issue  or 
that  can  be  made  fit  for  re-issue  at  the  cost  of  correspond- 
ing new  material,  but  to  prevent  carrying  such  used  ma- 
terial at  more  than  its  true  value  the  reserve  for  depre- 


TELEPHONE  COMPANY  ACCOUNTS         507 

ciation  of  supplies  should  be  utilized.  By  the  use  of  this 
account,  offsetting  to  some  extent  the  property  account 
called  Supplies,  the  used  material  can  for  accounting  pur- 
poses be  carried  at  its  face  value  in  the  property  account 
until  its  disposition  or  true  value  can  be  determined,  and 
meanwhile  the  net  assets  not  be  overstated. 

Each  of  these  three  classes  of  property  under  Working 
Assets  has  its  corresponding  expense  account. 

Furniture  expense  which  comprises  not  only  repairs  and 
changes  to  furniture,  but  also  depreciation  on  furniture 
and  fixtures  is  a  sub-account  for  each  department.  By  the 
methods  provided  in  a  standard  routine  known  as  Ac- 
counting Bulletin  8  A  the  face  value  of  all  office  furniture 
and  fixtures  used  by  any  department  or  any  district  may 
be  known  periodically.  The  rate  of  depreciation  having 
been  determined,  it  is  a  simple  matter  to  charge  each  de- 
partment monthly  the  depreciation  on  its  own  office  furni- 
ture and  fixtures,  while  repairs  or  changes  in  such  office 
furniture  and  fixtures  may  go  to  the  different  departments 
as  incurred.  It  has  seemed  to  some  that  this  is  an  over- 
elaborate  treatment  of  a  minor  account.  I  am  satisfied 
that  it  will  not  prove  to  be  so  in  practice,  for  this  class 
of  property  is  one  on  which  it  is  difficult  to  preserve  the 
truly  economical  course.  Properly  considered,  furniture  is 
a  tool  and  it  is  important  on  the  one  hand  to  have  this  tool, 
like  others,  adapted  to  its  purpose  so  as  to  get  the  greatest 
value  out  of  the  time  of  the  man  who  uses  it.  On  the  other 
hand  personal  fancies  and  other  influences  that  have  no 
bearing  on  efficiency  have  to  be  carefully  avoided.  The 
same  degree  of  efficient  oversight  should  be  given  to  furni- 
ture and  fixtures  as  to  tools  and  vehicles. 

Eepair  shops  which  were  formerly  carried  as  a  sepa- 
rate class  of  property  are  now  made  a  sub-account  of  Sup- 
plies. This  is  for  the  reason  that  most  of  the  important 
repairs  and  nearly  all  the  local  repair  shops  have  in  the 
last  few  years  been  turned  over  to  the  Western  Electric 


608         TELEPHONE  COMPANY  ACCOUNTS 

Company.  In  the  few  cases  where  repair  shops  are  still 
run  by  the  telephone  companies,  it  is  important  to  keep 
accounts  on  the  lines  commonly  adopted  by  factories  so 
as  to  make  up  correct  costs  of  different  repair  jobs.  Shop 
work  and  shop  accounts  are  so  different  from  the  other 
work  of  a  telephone  company  that  effective  supervision 
and  information  are  apt  to  be  lacking  as  compared  with 
the  standards  to  which  factory  men  are  accustomed. 

VII.   Current  Assets. 

The  next  general  class  of  property  is  comprised  under 
the  term  Current  Assets,  because  it  is  either  cash  or  is  to 
be  converted  into  cash  in  the  ordinary  course  of  business. 

The  account  Cash  and  Deposits  needs  no  explanation. 

Bills  Receivable  represent  debts  due  the  company  for 
which  promissory  notes  are  held,  such  notes  being  usually 
on  demand  or  for  short  terms. 

Accounts  Receivable  likewise  represents  debts  due  the 
company,  the  bulk  of  which  it  expects  to  collect  in  the  usual 
course,  but  for  which  it  holds  no  acknowledgement  of  the 
debtor.  It  is  important  to  distinguish  here  the  accounts 
which  for  any  reason  have  become  doubtful  of  collection, 
and  it  is  common  business  practice  to  anticipate  in  the 
bookkeeping  the  probable  non-collection  of  some  of  the 
doubtful  accounts.  While  accounts  are  in  the  doubtful  or 
suspense  stage  there  is  no  guide  except  experience  as  to 
the  amount  that  will  probably  not  be  collected.  Of  course 
no  accounts  known  to  be  uncollectible  should  be  carried 
as  assexs. 

The  last  class  of  these  current  assets  is  a  grouping  of 
accounts  known  as  Prepaid  Expenses.  These  represent  the 
payments  of  expenses  in  advance  of  the  periods  to  which 
they  pertain,  as  for  instance  insurance  premiums  may  be 
paid  in  the  month  of  January  covering  insurance  for  the 
entire  year  or  even  for  several  years.  It  would  obviously 
be  unfair  to  charge  all  these  premiums  to  the  January 


TELEPHONE  COMPANY  ACCOUNTS         509 

expenses,  and  in  fact  if  the  company  should  cancel  its  in- 
surance before  expiration  it  could  collect  part  of  the  pre- 
miums it  had  paid,  so  that  to  some  extent  the  prepaid 
expenses  are  convertible  into  cash.  The  case  is  not  so 
clear  for  treating  some  other  prepaid  expenses  as  if  they 
were  convertible  into  cash  but  in  general  it  is  fair  to  con- 
sider them  as  current  assets  because  as  to  directories  for 
instance,  since  the  company  will  unquestionably  continue 
in  business  during  the  period  for  which  it  has  provided 
directories,  the  amount  of  cash  that  will  be  needed  to  meet 
its  current  obligations  is  reduced  by  the  amount  of  this 
prepaid  directory  expense. 

Some  objection  has  been  made  to  considering  receipts 
from  advertising  in  directories  as  a  deduction  from  direc- 
tory expense,  it  being  suggested  that  it  should  be  included 
in  the  revenue.  Our  view  is  that  the  general  purpose  of 
directory  expense  should  govern  the  accounting.  Since  the 
directory  is  an  essential  feature  of  the  operation  of  a  tele- 
phone plant  it  follows  that  the  advertising  is  sought  wholly 
for  the  purpose  of  reducing  that  expense.  If  the  company 
published  directories  as  a  separate  business  venture,  which 
it  would  discontinue  should  the  venture  pay  no  net  return, 
the  accounting  treatment  would  be  different. 

VIII.  Securities  Owned. 

The  last  class  of  property,  to  which  reference  need  here 
be  made,  may  be  comprised  under  the  general  term  Securi- 
ties Owned.  These  are  mostly  stocks  and  bonds  of  allied 
companies  which  may  properly  be  carried  at  their  cost  so 
long  as  such  cost  does  not  exceed  the  true  value,  or  may 
be  inventoried  from  time  to  time  and  the  property  accoimt 
corrected  to  the  inventory  value. 

IX.  Capital  Obligations. 

Turning  now  from  the  asset  or  property  accounts  to 


510         TELEPHONE  COMPANY  ACCOUNTa 

the  liability  accounts  which  represent  the  source  of  the 
funds  with  which  the  property  has  been  purchased. 

For  convenience  we  may  distinguish  three  general 
classes  of  liabilities — 

Capital  Obligations, 
Current  Obligations, 
Reserves  and  Surplus. 

Capital  Obligations  are  of  several  different  forms,  their 
titles  usually  indicating  their  relative  standing  as  liens 
against  the  company's  property. 

Bonded  Debt  and  Real  Estate  Mortgages  are  usually 
first  liens  on  the  property.  When  such  obligations  fall 
due  they  must  be  satisfied  in  some  way  even  if  the  property 
has  to  be  sold  under  the  hammer  to  raise  the  cash. 

Bills  Payable  are  sometimes  ranked  as  current  obliga- 
tions because  commonly  they  do  not  run  very  long;  but  on 
closer  analysis,  I  think  (at  least  in  the  telephone  business)' 
they  are  usually  temporary  financing  to  provide  additional 
permanent  property.  On  this  theory  I  include  them  with 
capital  obligations. 

As  to  the  account  Bills  Receivable  Discounted,  the  ques- 
tion is  occasionally  asked  why  the  books  should  show  as  an 
obligation  a  promissory  note  to  the  company  which  it  has 
endorsed  and  sold  to  its  bankei-s  or  someone  else.  The  reas- 
on is  that  so  long  as  the  company  may  be  called  on  to  pay 
the  note  (which  will  happen  in  case  the  endorsement  leaves 
any  recourse  to  the  endorser  and  the  giver  of  the  note  fails 
to  pay)  the  company  has  an  obligation,  and  to  clearly  un- 
derstand the  company's  financial  status  every  liability,  di- 
rect or  contingent,  must  be  shown.  Of  course  such  notes 
would  also  appear  under  Bills  Receivable  in  the  property 
accounts. 

The  last  and  usually  largest  capital  obligation  is  Cap- 
ital Stock  representing  the  ownership  of  the  business.  This 
is  always  the  last  lien  on  the  property  or  rather  is  no  lien, 


TELEPHONE  COMPANY  ACCOUNTS         511 

at  all,  but  in  a  dissolution  gets  whatever  is  left  after  all  oth- 
er obligations  are  satisfied. 
X.   Current  Liabilities. 

Current  Liabilities  in  general  represent  the  obligations 
falling  due  in  the  ordinary  course  of  the  business  and  to 
meet  which  cash  must  be  currently  provided. 

Of  these,  Accounts  Payable  are  usually  the  most  import- 
ant. It  is  common  practice  to  compare  the  Accounts  Pay- 
able with  the  cash  on  hand  so  as  to  know  the  company's  im- 
mediate financial  situation.  A  closer  analysis  is  however 
advisable  since  for  instance,  some  current  accounts  pay- 
able may  not,  under  the  terms  of  payment  be  due  for  one  or 
two  months,  and  while  cash  may  be  low  at  the  end  of  the 
month  it  may  be  safe  to  rely  on  the  collection,  during  the 
first  part  of  the  next  month,  of  a  certain  proportion  of  Ac- 
counts Receivable.  Accounts  Payable  are  for  convenience 
classifi,ed  according  to  the  parties  to  whom  they  are  pay;- 
able. 

The  Account  Accrued  Liabilities  not  Due  may  in  a  way 
be  called  the  opposite  of  the  asset  account  Prepaid  Expens- 
es. While  Prepaid  Expenses  represent  payments  for  ex- 
penses in  advance  of  the  periods  to  which  they  pertain, 
Accrued  Liabilities  not  Due  represent  the  expenses  which 
are  not  payable  until  after  the  period  to  which  they  pertain. 

The  necessity  for  these  two  accounts  lies  in  the  fact  that 
we  attempt  to  make  accurate  statements  each  month  of  the 
business  results  for  that  month,  whereas  some  kinds  of  ex- 
penses as  taxes,  insurance  and  interest  may  be  payable 
annually  or  quarterly  instead  of  monthly. 

It  is  necessary  also  to  provide  a  Liability  account  for 
Unearned  Revenue,  because  in  some  cases  bills  for  service 
are  rendered  in  advance  for  a  period  of  three  months  or 
more,  whereas  after  the  month  in  which  the  money  is  re- 
ceived the  company  is  stUl  under  obligation  to  furnish 
service  for  a  further  period.   This  account  therefore  is  also 


512         TELEPHONE  COMPANY  ACCOUNTS 

needed  in  order  to  make  the  monthly  statements  cover  only 

the  month's  business. 

XI.    Reserves  and  Surplus. 

In  a  general  way  it  may  be  said  that  reserves  and 
surplus  (sometimes  called  Surplus  Reserves)  represent 
the  company's  provision  against  impairment  of  its  cap- 
ital under  all  possible  contingencies,  some  of  which  can 
be  foreseen  but  their  probable  cost  cannot  be  known, 
while  others  cannot  be  foreseen  but  are  part  of  the  risk 
and  uncertainty  which  must  accompany  all  human  un- 
dertakings. 
1.    Replacement  Reserves. 

The  account  about  which  there  is  generally  the  most 
discussion  is  that  bearing,  in  the  new  accounting  circu- 
lar, the  title  Replacement  Reserves.  Perhaps  the  best 
way  to  get  an  understanding  of  the  meaning  and  use  of 
this  account  is  to  consider  here  in  one  place  all  the  ac- 
counts to  which  it  is  related  and  to  confine  the  discus- 
sion for  the  moment  only  to  Plant.  Next  let  us  disre- 
gard the  terms  Construction,  Reconstruction  and  Main- 
tenance and  fix  our  minds  on  these  terms, — New  Plant 
Built,  Old  Plant  Removed,  Cost  of  Removal,  Salvage, 
Repairs,  Depreciation  and  Replacement  Reserve.  These 
terms  comprise  and  roughly  describe  all  the  transac- 
tions that  relate  to  the  subject.  The  logical  and  correct 
way  to  account  for  these  transactions  is  as  follows : 

(a)  As  new  plant  is  built,  whether  it  represents  addi- 
tions to  the  system  or  replaces  old  plant,  the  cost 
of  building  such  new  plant  is  charged  to  the  prop- 
er plant  account. 

(b)  As  the  plant  is  repaired  so  as  to  keep  it  in  work- 
ing order,  the  cost  of  the  repairs  which  cannot  be 
considered  as  adding  to  the  original  value  of  the 
property,  must  be  charged  to  expense. 

(c)  It  cannot  be  doubted  that  every  part  of  the  plant 
is,  in  spite  of  repairs,  gradually  and  in  some  cases 


TELEPHONE  COMPANY  ACCOUNTS         513 

imperceptibly  deteriorating  so  that  it  will  at  some 
time  in  the  future  have  to  be  abandoned  or  re- 
placed. In  addition  to  this  general  but  gradual 
deterioration  there  are  two  probable  causes  for  fu- 
ture replacement,  known  as  obsolescence  and  in- 
adequacy. Obsolescence  arises  from  the  fact  that 
by  the  progress  of  invention  old  types  of  plant 
have  sometimes  to  be  discarded  before  they  are 
worn  out,  because  more  efficient  types  must  take 
their  place.  Inadequacy  may  be  caused  by  advanc- 
es in  the  art  or  by  more  rapid  growth  than  was 
foreseen,  or  by  public  regulation. 

The  consensus  of  opinion  of  accountants  and 
other  students  of  the  question  is  that  this  grad- 
ual deterioration,  obsolescence  and  inadequacy, 
grouped  together  under  the  general  name  of  de- 
preciation, should  be  provided  for  out  of  the 
earnings  (or  in  other  words  charged  to  expenses) 
as  fast  as  it  is  estimated  to  accrue.  This  means 
that  there  must  be  a  monthly  charge  to  expenses 
representing  the  estimated  accrued  depreciation 
for  the  month. 

(d)  Now  since  this  is  not  at  once  a  cash  outlay  the 
charge  to  expenses  must  be  offset  by  an  equal 
credit  to  some  account.  For  that  account  we 
adopt  the  general  term  Replacement  Reser^^es, 
thereby  recognizing  that  this  provision  is  made 
to  replace  the  plant  when  it  has  to  be  taken  out 
for  any  of  the  causes  called  depreciation. 

(e)  As  old  plant  is  taken  out  for  these  causes  it  is 
clear  that  the  plant  account  should  be  accordingly 
decreased  because,  being  no  longer  in  existence, 
■the  books  should  no  longer  show  it  as  an  asset. 
Old  plant  removed  is  therefore  credited  to  the 
proper  plant  account  and  charged  to  Replace- 


B.VIII— 33 


^li         TELEPHONE  COMPANY  ACCOUNTS 

ment  Eeserve,  which,  as  just  stated  has  been  pro- 
vided for  that  purpose. 

(f)  But  the  provision  for  depreciation  if  correctly 
made  recognizes  that  there  would  be  some  sal- 
vage from  the  old  plant  when  taken  out  and 
that  the  cost  of  removing  the  old  plant  so  as  to  re- 
cover the  salvage  would  reduce  the  net  value  of 
that  salvage.  This  net  value  of  salvage  must 
then  be  credited  to  Replacement  Reserve. 

(g)  As  old  plant  is  removed  it  may  or  may  not  be  re- 
placed by  new  plant  or  if  replaced,  the  new  plant 
may  be  of  different  character.  This  however 
does  not  affect  any  of  the  foregoing  since  the  cost 
of  any  new  plant,  for  whatever  reason  built,  be- 
comes at  once  an  addition  to  the  plant  accounts. 

Although  these  processes  are  for  convenience 
somewhat  expanded,  in  practice,  it  is  simpler  to  per- 
form than  to  describe  them.  It  is  important  that  they 
be  generally  comprehended  because  they  comprise  the 
only  known  method  by  which  the  transactions  that 
really  occur  can  be  recorded  on  the  books. 

The  question  is  raised  as  to  the  growth  of  this  ac- 
count, Replacement  Reserves.  We  show,  for  instance, 
that  the  Associated  Bell  Operating  Companies  in  the 
United  States  during  the  first  ten  months  of  the  year 
1909  charged  to  expenses  for  depreciation  nearly  $11,- 
000,000  more  than  was  required  to  take  care  of  old 
plant  taken  out  of  service  during  that  period.  The 
reason  and  necessity  for  this  is  as  follows.  The  bulk 
of  the  present  plant  of  the  Bell  Companies  has  been 
built  within  the  past  five  years  and  has  not  yet  dete- 
riorated to  the  point  of  replacement.  The  old  plant  now 
coming  out  of  service  is  that  built  ten,  fifteen  or  twen- 
ty years  ago.  Since  the  whole  plant  was  then  very 
much  smaller  than  it  is  now,  replacements  actually  tak- 
ing place  now  are  less  than  they  will  be  ten,  fifteen  or 


TELEPHONE  COMPANY  ACCOUNTS         515 

twenty  years  from  now.  But  depreciation  is  accruing 
on  tlie  present  enormous  plant  day  by  day,  month  by 
month  and  year  by  year.  It  is  this  depreciation  we  are 
providing  for  out  of  present  earnings,  not  that  which 
began  accruing  ten,  fifteen  or  twenty  years  ago. 

2.  Reserve  for  Sinking  Fund. 

By  the  terms  of  some  bonds  a  so-called  sinking  fund 
must  be  provided. 

Reserve  for  Sinking  Fund  means  that  part  of  the 
net  earnings,  instead  of  being  paid  out  in  dividends 
or  added  to  surplus,  are  set  aside  to  be  used  to  pay  off 
bonded  debt.  This  money  so  set  aside  is  commonly 
turned  over  to  a  trustee  who  invests  it  till  the  bonds 
are  due;  such  investments  and  the  income  from  them 
being  carried  in  a  special  property  account  called  Sink- 
ing Fund.  When  the  bonds  are  thus  paid  off  the  re- 
serve for  sinking  fund  has  served  its  purpose  and 
may  go  back  to  surplus,  having  been  in  the  meantime 
an  appropriation  from  surplus  to  safeguard  the  security 
of  bondholders.  But  it  is  not  always  provided  in  the 
mortgage  securing  the  bonds  that  the  additions  to  sink- 
ing fund  must  be  met  out  of  earnings  before  dividends 
are  paid,  nor  is  this  necessary  for  the  bondholders'  pro- 
tection when  proper  provision  for  depreciation  is  taken 
out  of  earnings  and  put  in  replacement  reserves. 
In  such  cases  it  is  a  common  practice  not  to  set  up  a 
reserve  for  sinking  fund  at  all  but  to  transfer  the 
stipulated  amounts  from  the  asset  account  Cash,  which 
is  under  the  company's  control  to  the  asset  account 
Sinking  Fund,  which  is  under  the  control  of  a  trustee 
for  the  bondholders. 

3.  Surplus. 

The  general  purpose  of  surplus  is  similar  to  that  of 
replacement  reserves  and  reserves  for  sinking  funds, 
viz.,  to  keep  the  capital  from  becoming  impaired.  Re- 
placement  reserves   and  reserves   for  sinking  funds 


516         TELEPHONE  COMPANY  ACCOUNTS 

however  relate  to  specific  propert}^  or  specific  debts, 
while  surplus  may  be  used  for  any  contingencies  that 
may  arise.  In  fact  a  part  of  surplus  is  sometimes  called 
*' Contingent  Reserve"  or  some  similar  name. 

It  frequently  happens  that  the  stockholders  prefer 
to  take  smaller  dividends  and  leave  the  balance  of  the 
earnings  as  additional  capital  in  the  business,  or  the 
business  may  have  such  hazards  as  to  property  values 
or  such  fluctuations  in  earnings  that  the  safeguarding 
of  regular  and  steady  dividends  at  an  average  rate  can 
best  be  attained  through  the  surplus  account. 

The  source  of  surplus  too  is  somewhat  different 
from  that  of  replacement  reserves.  The  additions  to 
the  latter  are  properly  a  part  of  expenses  and  as  such 
come  out  of  revenue  before  dividends  can  be  paid  from 
current  revenue,  while  surplus  commonly  represents  the 
accumulations  of  net  revenue  after  dividends  have  been 
paid. 

Without  entering  into  fine  distinctions  however  it 
helps  to  understand  the  general  status  of  a  company 
with  respect  to  its  property  on  the  one  hand  and  its 
obligations  on  the  other  if  the  surplus  and  these  re- 
serves are  grouped  together. 

XII.    Revenue. 

The  various  terms  Revenue,  Earnings,  Income  and  Re- 
ceipts are  often  used  more  or  less  loosely  to  represent  about 
the  same  thing.  We  use  the  term  Revenue  as  being  per- 
haps the  least  ambiguous.  In  the  best  modern  accounting 
practice  the  revenue  is  deemed  to  be  earned  in  the  period 
during  which  the  service  is  rendered,  whether  the  money 
is  all  received  in  that  period  or  not. 

There  are  two  principal  sources  of  telephone  revenue — 
that  from  exchange  service  and  that  from  toll  ser\ace. 
While  the  general  distinction  between  the  two  is  plain, 
it  becomes  necessary  in  practice  to  make  as  exact  'defini- 


TELEPHONE  COMPANY  ACCOUNTS         517 

tions  as  possible  and  in  some  doubtful  cases,  to  make  arbi- 
trary rulings. 

Exchange  Service  is  defined  for  accounting  purposes  as 
the  transmission  of  messages  by  telephone  between  two 
stations  both  of  which  are  within,  or  receiving  local  service 
from,  the  same  exchange  service  area.  An  exchange 
service  area  is  that  area  referred  to  and  usually  described 
in  the  company's  contracts  with  its  subscribers  within 
which  local  service  is  furnished  subscribers  at  rates  speci- 
fied in  such  contracts. 

Having  defined  exchange  service,  it,  of  course,  follows 
that  toll  service  covers  the  transmission  of  messages  by 
telephone  between  two  stations  in  different  exchange 
service  areas. 

Under  exchange  service  the  bulk  of  the  revenue  is,  of 
course,  that  from  subscribers.  Much  consideration  was 
given  to  various  suggestions  for  sub-dividing  revenue  from 
subscribers'  stations  among  various  classes  of  stations  but 
it  appeared  that  the  sub-divisions  possible  of  general  appli- 
cation, would  be  of  little  practical  value  in  many  places. 
It  was  finally  decided  to  provide  the  optional  sub-accounts 
shown  in  the  circular,  with  the  thought  that  they  would 
be  used  chiefly  for  the  larger  cities  and  perhaps  still  further 
amplified  in  the  largest  cities. 

The  revenue  from  pay  stations  is  generally  of  a  dis- 
tinctive character  so  as  to  be  easily  segregated. 

Other  accounts,  provided  under  exchange  revenue,  are 
believed  to  be  needed  not  only  so  that  such  revenue  can  be 
known  and  thereby  greater  effort  made  to  increase  it,  but 
also  that  subscribers'  revenue  may  not  be  loaded  up  with 
items  which  have  no  particular  relation  to  the  contracts 
with  subscribers. 

Under  toll  revenue  we  distinguish  two  main  classes. 
First,  the  revenue  from  toll  messages  entirely  over  the 
company's  lines,  known  as  company  tolls,  and  next,  the 
revenue  known  as  foreign  tolls  which  represents  the  com- 


618  TELEPHONE  COMPANY  ACCOUNTS 

pany's  proportion  of  the  revenue  from  toll  messages,  one 
or  both  terminal  points  of  which  are  not  on  the  company's 
lines.  Optional  sub-accounts,  under  both  these  heads,  have 
been  provided  to  distinguish  intrastate  from  interstate 
tolls. 

It  may  be  well  here  to  indicate  Avhat  is  generally  meant 
by  the  company's  proportion  of  foreign  tolls.  A  toll  mes- 
sage frequently  passes  over  the  lines  of  two  or  more  com- 
panies, the  whole  revenue  however  being  collected  by  one 
company.  The  division  of  revenue  is  made  on  a  basis 
described  in  contracts  between  the  connecting  companies, 
being  either  prorated  according  to  mileage  or  a  commission 
allowed.  The  collecting  company  then  receives  not  only 
its  own  revenue  from  the  message  but  also  acts  as  an  agent 
in  collecting  and  paying  over  to  the  other  company  or  com- 
panies their  revenue  from  the  message.  The  revenue  col- 
lected on  behalf  of  others  is  not  revenue  of  the  collecting 
company  and  if  for  bookkeeping  convenience  it  is  originally 
included  under  revenue  it  must  be  deducted  therefrom  each 
month. 

Other  sub-accounts  of  revenue  are  provided  along  the 
lines  that  experience  seems  to  indicate  will  be  found  useful. 

XIII.    Expenses. 

In  the  classification  of  expenses  more  changes  have  been 
made  and  more  sub-accounts  have  been  introduced  than 
in  any  other  part  of  the  accounting  system.  The  reason 
for  this  is  a  natural  one,  relating  to  the  growth  of  the  tele- 
phone industry. 

The  alert  manager  of  a  small  business  sees  with  his 
own  eyes  the  improvements  that  should  be  made  in  order 
to  keep  his  expenses  do^m  and  his  service  up  and  these 
things  he  can  correct  on  the  spot  by  verbal  directions  or 
perhaps  with  his  ot\ti  hands. 

As  a  business  grows  the  administrative  head  has  to 
depend  partly  on  similar  action  by  his  subordinates,  veri- 


TELEPHONE  COMPANY  ACCOUNTS         519 

fied  by  their  reports  to  him,  and  partly  by  the  financial 
results  as  disclosed  in  the  bookkeeper's  reports.  From 
this  point  on,  the  supervision  of  the  business  depends  large- 
ly on  the  development  of  organization  and  accounts. 

From  very  humble  beginnings  the  Bell  system  has 
passed  through  successive  periods  of  experimentation,  edu- 
cation of  the  public  to  the  use  of  the  telephone  and  en- 
listment of  capital,  to  the  construction  of  great  plants  and 
the  building  up  of  great  organizations  to  care  for  a  great 
public  utility. 

The  development  of  the  industry  has  now  reached  the 
period  when  efficient  conduct  of  daily  routine  is  to  be  a 
great  and  perhaps  the  dominant  feature.  Complete  and 
detailed  information  as  to  expenses  are  an  essential  part 
of  such  a  program.  We  make  no  apology  for  insisting 
on  this  as  a  vital  part  of  the  accounting  of  the  Bell  system. 

The  clerical  processes  by  which  such  detailed  informa- 
tion can  be  obtained  are  outlined  in  the  standard  routines 
just  published,  which  are  believed  to  be  the  most  efficient 
that  can  be  devised  to  meet  present  conditions.  We  confi- 
dently expect  that  the  development  of  mechanical  account- 
ing processes  can  reduce  the  clerical  work  involved  for 
detailed  expense  accounts  considerably  below  what  it  has 
been  for  the  simple  accounts  used  in  the  past. 

The  sound  principle  for  uniform  expense  accounting  in 
large  companies  is  that  classifications  should  conform  to 
the  predominant  type  of  organization.  The  type  of  organ- 
ization now  predominant  and  being  more  and  more  gen- 
erally adopted  as  its  advantages  are  more  clearly  under- 
stood, is  commonly  known  as  * 'functional,"  that  is  depart- 
mentalized throughout  the  field  according  to  classes  of 
work,  with  each  class  of  work  wherever  performed  under 
the  jurisdiction  of  one  department.  The  departments  gen- 
erally recognized  are: 
Executive, 
Accounting, 


520         TELEPHONE  COMPANY  ACCOUNTS 

Financial, 
Legal, 
Commercial, 
Traffic, 
Plant. 
Of  these,  there  are  three  de'partments  directly  responsible 
for  the  greatest  expenditure  of  money,  viz. : — the  Commer- 
cial, Traffic  and  Plant  Departments. 

In  the  Commercial  and  Traffic  Departments  the  ac- 
counts believed  to  have  the  greatest  administrative  value 
have  been  provided.  These  in  some  cases  represent  sub- 
departments,  but  this  principle  has  not  been  blindly  fol- 
lowed, because  it  has  seemed  in  the  analysis  of  expenses 
better  to  emphasize  by  segregation  certain  expenses  which 
from  their  nature  are  relatively  large;  as  for  instance, 
Operators'  Wages. 

The  Plant  Department  necessarily  requires  in  the  ac- 
counts special  treatment  because  this  department  in  gen- 
eral manages  the  building  of  new  plant  (which  goes  to  the 
property  accounts),  removal  of  old  plant  (which  is  a  charge 
to  Replacement  Reserves)  and  repairs  to  plant  (which  are 
charged  to  expenses). 

While  the  detail  work  of  all  these  transactions  can  be 
directly  charged  to  the  appropriate  account,  general  super- 
vision of  such  work  cannot  be  conveniently  or  accurately 
distributed  at  the  time  the  expenditure  is  made.  This 
condition  is  provided  for  by  classifying  all  plant  supervi- 
sion expenses  under  a  special  account,  which  at  the  end 
of  every  month  is  "cleared,"  that  is,  divided  among  other 
accounts.  Another  advantage  in  treating  plant  supervision 
expense  in  this  way  is  that  all  such  expenses  are  first  put 
together  in  one  place,  so  that  a  report  for  administrative 
uses  can  be  conveniently  made  up. 

This  in  general  is  the  principle  followed  in  all  clearing 
accounts.  Thus  all  real  estate  expenses  can  by  this  means 
be  kept  together  for  the  month  and  apportioned  as  rent 


TELEPHONE  COMPANY  ACCOUNTS         521 

to  the  various  departments,  depending  on  the  area  and 
character  of  floor  space  they  use.  Likewise  tool  expense 
and  stable  and  garage  expense  have  to  be  apportioned 
to  different  classes  of  accounts,  depending  on  the  use  made 
of  the  property  included  under  the  account  Tools  and 
Vehicles.  Supply  expenses  also  have  to  be  distributed  to 
different  accounts,  depending  on  the  accounts  to  which  the 
material  delivered  from  supplies  has  been  charged. 

Reference  has  already  been  made  to  repairs  as  related 
to  plant  and  replacement  reserves.  I  shall  not  here  comment 
on  its  meaning  or  discuss  the  interpretations  that  have 
been  developed  concerning  it.  The  sub-accounts  of  re- 
pairs are  a  condensation  of  the  corresponding  accounts  of 
plant.  The  main  purpose  in  this  is  to  get  unit  costs  of 
repairs. 

Occasionally  a  severe  sleet  storm  throws  a  heavy  burden 
on  repairs  and  it  may  be  noted  in  passing  that  a  method 
of  making  provision  in  advance  for  this  occasional  heavy 
burden,  or  of  equalizing  it  among  months,  has  been  pro- 
vided. 

The  expense  account  which  shows  the  cost  of  the  con- 
stant shifting  in  telephone  stations,  previously  referred  to, 
is  known  as  Station  Removals  and  Changes^  and  the  infor- 
mation possible  through  this  account  will  be  found  to  be 
of  great  importance. 

These  three  accounts,  Repairs,  Station  Removals  and 
Changes,  and  Depreciation  of  Plant,  comprise  what  is  com- 
monly known  as  Maintenance,  all  of  which  is  usually  a 
responsibility  of  the  plant  department. 

We  come  next  to  some  other  expenses  which  are  not 
precisely  departmental  expenses.  These  include  rights, 
privileges  and  use  of  property,  the  new  definition  of  which 
expresses  clearly,  we  believe,  the  purpose  of  such  expense 
and  the  meaning  of  this  account.  Insurance  and  taxes 
complete  the  classes  of  expenses. 

Now  having  ascertained  all  the  expenses, — among  which 


522         TELEPHONE  COMPANY  ACCOUNTS 

sufficient  depreciation  should  have  been  included, — they 
may  be  subtracted  from  revenue  and  the  difference  will 
represent  the  net  earnings  of  the  business  for  the  period. 
From  the  net  earnings  must  first  be  deducted  the  interest 
pertaining  to  the  period  on  all  the  company's  indebted- 
ness. The  balance  represents  the  earnings  on  capital  stock, 
most  of  which  in  common  practice  goes  to  the  shareholders 
in  the  form  of  dividends,  the  balance,  if  any,  being  added 
to  Surplus. 

XIV.  Non- Functional  Exchange  Expenses. 

As  already  explained  the  accounts,  particularly  the  ex- 
pense accounts,  are  primarily  designed  for  and  adapted  to 
a  company  having  the  functional  form  of  organization. 
But  even  a  company  so  organized  may  have  small  or  iso- 
lated exchanges  where  it  is  advantageous  to  have  all  the 
classes  of  local  w^ork  under  the  general  supervision  of  one 
local  man,  and  indeed  there  are  large  comjDanies  made  up 
chiefly  of  small  exchanges  of  this  character  and  wdth  this 
organization.  It  is  to  take  care  of  such  cases  that  the  ac- 
count known  as  Non-Functional  Exchange  Expenses  has 
been  devised.  By  this  means  the  expenditures  made  under 
the  direction  of  Exchange  Managers  may  come  through 
the  books  and  be  concentrated  in  one  account  without  first 
making  a  theoretical  sub-division  according  to  departments. 
Having  been  aggregated  in  one  account  how^ever  they  must, 
for  the  sake  of  general  uniformity  and  the  combination 
of  all  accounts,  be  apportioned  as  if  departmental  lines 
existed,  a  method  for  such  apportionment  being  provided. 

XV.  Geographical  Areas. 

Many  companies,  particularly  the  larger  ones,  cover  so 
broad  a  territory  that  it  is  important  to  know  the  prop- 
erty, revenue  and  expenses  sub-divided  into  geographical 
areas.  This  is  a  difficult  branch  of  the  accounting  not  only 
because  it  involves  great  detail  but  more  particularly  be- 
cause carried  to  its  extreme  it  involves  apportionment  of 


TELEPHONE  COMPANY  ACCOUNTS         523 

so  large  a  proportion  of  revenue  and  expenses  as  to  se- 
riously invalidate  the  results.  It  is  obvious,  for  instance, 
that  to  the  man  in  charge  of  work  in  a  given  geographical 
area  the  proportion  of  general  expenses  charged  him  on 
some  arbitrary  basis  has  no  vital  meaning.  He  knows  that 
the  accuracy  of  the  amount  of  general  expenses  charged 
cannot  be  substantiated  as  actually  incurred  for  the  benefit 
of  his  district,  and  that  even  if  it  w^ere  correct,  it  would 
be  beyond  his  power  to  reduce  it  by  his  own  efforts.  At 
the  same  time  it  is  important  that  the  expenses  which  are 
incurred  under  his  supervision  should  be  segregated  and 
known  both  to  his  administrative  superior  and,  in  my  judg- 
ment, to  himself. 

The  reasonable  course  appears  to  be  to  segregate  by 
the  geographical  areas  used  for  administrative  purposes, 
the  revenue  and  expenses  which  directly  pertain  to  each 
such  area  and  to  apply  the  administrative  pressure  to  get 
better  results  by  means  of  a  comparison  of  such  direct  re- 
sults in  different  areas,  or  for  different  periods  in  the  same 
area. 

XVI.    Reports. 

There  are  in  every  business  two  fundamental  financial 
reports,  the  balance  sheet  as  of  a  given  date  and  the  earn- 
ings report  for  a  stated  period.  The  balance  sheet  com- 
prises on  the  one  hand  the  assets  or  property,  and  on  the 
other  hand  the  liabilities.  Including  surplus,-  the  liabili- 
ties must  always  exactly  equal  the  assets.  The  earnings 
report  shows  in  greater  or  less  detail,  the  revenue,  ex- 
penses, net  earnings,  interest,  dividends,  and  the  balance, 
if  any,  added  to  surplus. 

All  other  reports  from  the  books,  of  which  there  may 
be  an  infinite  variety,  are  subordinate  to  these  two  principal 
reports  and  serve  to  amplify  or  explain  details  and  make 
v3omparisons. 

While  the  general  situation  of  a  business  cannot  be 
understood  without  the  balance  sheet  and  earnings  re- 


524         TELEPHONE  COMPANY  ACCOUNTS 

port,  the  success  and  value  of  an  accounting  system  must 
depend  largely  on  the  fomi  of  the  subordinate  reports  and 
the  use  made  of  the  information  they  furnish. 

Conclusion. 

Only  time  and  experience  will  really  show  to  what  de- 
gree this  accounting  plan  is  permanent.  Our  belief  is  that 
it  affords  a  foundation  on  which  can  be  built  all  the  im- 
provements and  changes  that  may  from  time  to  time  be 
wanted  to  assist  and  guide  the  development  of  the  business. 

Many  good  people  in  this  country  observe  with  anxiety 
the  increasing  concentration  of  business  enterprises  into 
fewer  and  fewer  organizations,  fearing  the  elimination  of 
competition.  They  forget  that  this  same  economic  process 
by  stimulating  competition  between  individuals  in  the  same 
business  is  developing  the  high  degree  of  individual  effi- 
ciency that  has  made  possible  the  steady  advance  in  wages 
of  all  classes  of  labor. 

A  most  important  accounting  work  for  the  future  lies, 
I  think,  in  the  endeavor  to  show  through  accounting  sys- 
tems the  relative  efficiency  of  individuals.  Perhaps  it  is 
not  an  idle  dream  to  imagine  that  the  time  may  come  when 
it  will  be  as  much  a  function  of  an  accounting  system  to 
show  to  each  individual  employe  the  results  of  his  labor 
as  it  now  is  to  show  to  each  stockholder  the  result  of  his 
investment  of  money. 

This  tendency,  whatever  practical  limits  it  may  prove 
to  have,  means  now  not  only  that  administrative  officers 
must  understand  what  the  accounts  say  for  their  larger 
fields  of  responsibility  but  that  department  heads  and 
individual  employes  must  begin  to  learn  what  the  accounts 
teach  about  their  work. 

There  need  be  nothing  mysterious  or  obscure  about  ac- 
counts and  accounting  reports.  They  can  and  should  be 
so  stated  that  anyone,  having  such  an  understanding  of 
arithmetic  and  language  as  a  common  school  education 
affords,  can  readily  fit  himself  to  understand  them. 


CJESTIONS  IN 
BUSINESS  ADMINISTRATION 
ACCOUNTING 

Fundamental  Ideas. 

1.  What  erroneous  uses  are  made  of  tlie  word  "account- 
ing"? Page  3. 

2.  In  what  way  is  accounting  related  to  the  science  of 
economics?  Page  4. 

3.  What  is  the  relation  between  the  accountant  and  the 
bookkeeper?  Page  4. 

4.  What  has  caused  the  evolution  of  the  accounting  pro- 
fession? Page  5. 

5.  What  subjects  does  the  regular  examination  for  pub- 
lic accountants  now  include?  Page  8. 

Construction  of  the  Account. 

1.  What  is  lacking  in  a  classification  of  "bought"  and 
"sold"?  Page  11. 

2.  What  do  the  terms  "debtor"  and  "creditor"  mean 
as  used  in  an  account?  Page  11. 

3.  What  is  an  account?  Page  13. 

4.  What  should  an  accounting  system  show?   Page  14. 

5.  What  is  a  nominal  account?    Illustrate.         Page  15. 

6.  Illustrate  a  real  or  property  account.  Page  16. 

7.  Give  two  reasons  for  keeping  personal  accounts. 

Page  16. 

8.  On  June  1,  James  Brown  bought  144  boxes  of  straw- 
berries for  $8.00.  On  June  1,  he  sold  60  boxes  at  10 
cents  per  box.  On  June  2,  he  sold  80  boxes  at  10  cents 
per  box,  and  4  boxes  spoiled.  He  had  to  pay  50  cents 
for  the  use  of  a  cart.  Show  how  his  cash  account  would 

525 


626  QUIZ  QUESTIONS 

appear  at  the  end  of  June  2.  Pages  17-23. 

9.    What  is  meant  by  the  double  entry  system  of  book- 
keeping? Page  24. 
Keeping  the  Books. 

1.  Why  would  the  day  book  alone  be  an  insufficient  rec- 
ord of  the  transactions  of  a  business  ?  Page  26. 

2.  What  is  the  nature  of  the  ledger?  Page  26. 

3.  What  is  the  purpose  of  the  journal?  Page  27. 

4.  Illustrate  the  journalizing  of  a  transaction.  What 
does  it  indicate?  Page  28. 

5.  What  is  the  best  classification  of  the  day  book? 

Page  30. 

6.  What  is  the  general  ledger?  Page  32. 

7.  Wliat  is  the  cash  book?  Page  33. 

8.  Wlien  is  an  account  said  to  be  balanced?      Page  35. 

9.  How  is  a  trial  balance  prepared?  Page  36. 

10.  How  is  the  net  worth  of  a  business  determined  ? 

Page  40. 

11.  Of  what  does  the  balance  sheet  consist?         Page  41. 

Capital. 

1.  How  should  the  capital  account  be  kept  in  the  ease 
of  a  partnership?  Page  45. 

2.  What  is  an  installment  book?  Page  47. 

3.  If  John  Smith  has  30  shares  in  a  concern  and  wishes 
to  transfer  20  shares  to  R.  Jones,  how  is  the  exchange 
of  shares  recorded?  Page  49. 

4.  What  is  treasury  stock?  Page  50. 

5.  How  does  the  privilege  of  allowing  some  stockholders 
to  furnish  property  in  payment  for  stock  afford  a 
shrewd  money-making  scheme?  Page  51. 

6.  What  gives  rise  to  a  good- will  account?  A  surplus 
account?  Pages  52,  53. 

7.  What  is  the  erroneous  idea  as  to  the  reason  for  a  con- 
cern's issuing  bonds?  Page  54. 


ACCOUNTINa  527 

Cash  Account 

1.  Smifh  and  Brown  each  contribute  to  the  capital  $4,000 
in  the  form  of  checks.  The  cashier  deposits  them  in 
the  First  National  Bank.  Give  two  methods  of  keep- 
ing a  record  of  the  transactions.  Pages  57,  58. 

2.  Jones  buys  of  Smith  &  Brown  $500  worth  of  goods  and 
gives  his  note  in  exchange.  Show  how  this  will  ap- 
pear on  the  books  of  Smith  &  Brown.  Page  60. 

3.  The  bank  takes  Smith  &  Brown's  note  of  $500,  credit- 
ing their  account  with  the  amount,  but  exacting  $2.50 
discount.  How  should  this  discount  be  accounted  for 
on  the  books  of  Smith  &  Brown*?  Page  63. 

4.  If  Jones  dishonors  his  note,  what  course  will  the  bank 
take?    How  will  this  change  the  accounting? 

Page  64. 

5.  If  the  note  had  not  been  discounted  but  had  been  dis- 
honored by  Jones  when  directly  presented  by  the  firm, 
what  entries  would  have  been  made?  Page  65. 

6.  If  Smith  &  Brown  secure  a  renewal  of  a  bill  they 
owe,  how  is  the  accounting  affected?  Page  67. 

7.  What  is  the  relationship  between  cash,  bank,  bills  re- 
ceivable, and  bills  payable?  Page  67. 

8.  Give  an  example  of  a  contingent  liability.    Page  68. 

Goods  Accounts. 

1.  What  is  an  *  inward  returns"  book?  An  "outward 
returns"  book?  Page  71. 

2.  Jones  &  Jones,  having  goods  to  the  amount  of  $10,000, 
sold  to  J.  Jackson  $1,500  worth  of  goods.  On  unpack- 
ing, Jackson  found  that  $250  worth  of  the  goods  were 
damaged,  and  he  returned  them.  How  would  these 
transactions  appear  on  the  books  of  Jones  &  Jones? 

Page  72. 

3.  Smith  &  Brown  receive  from  Thomas  Taylor  a  con- 
signment of  goods  worth  $100.    They  sell  the  goods 


528  QUIZ  QUESTIONS 

for  $150.  After  deducting  their  commission  of  10  per 
cent,  and  freight  charges  amounting  to  $2,  a  draft 
for  the  remainder  is  remitted  to  Taylor.  How  would 
the  accounts  appear  on  the  books  of  Smith  &  Brown? 

Page  77. 

4.  Elustrate  the  trading  account.  Pages  78-82. 

5.  What  does  an  inventory  show?  Page  83. 

Plant  and  Property  Accounts. 

1.  Of  what  do  plant  and  property  accounts  consist? 
Illustrate.  Pages  85-87. 

2.  What  uses  may  be  made  of  the  money  held  in  the  busi- 
ness to  represent  the  value  of  destroyed  or  wasted  as- 
sets which  have  depreciated  in  value?  Page  89. 

3.  What  are  the  objections  to  the  process  of  writing 
down  assets  to  correspond  with  their  true  value  ? 

Page  90. 

4.  At  the  end  of  a  year's  business  a  firm  finds  that  there 
is  a  deterioration  amounting  to  $250  in  its  plant  and 
property.  To  offset  such  depreciation,  U.  S.  bonds 
are  bought.  How  will  this  transaction  be  shown  on 
the  books?  Pages  91,  92. 

5.  What  is  a  depreciation  reserve?  Page  92. 

6.  Illustrate  a  transfer  of  fixed  assets  into  floating. 

Page  94. 

7.  What  is  the  most  practical  method  of  accounting  for 
depreciation?  Page  95. 

8.  Name  the  causes  of  deterioration.  Page  96. 

9.  What  factors  must  be  considered  in  estimating  de- 
preciation? Page  98. 

10.  What  is  the  effect  of  a  too  cautious  depreciation  pol- 
icy? Page  101. 

11.  How  does  a  bank  safeguard  capital  against  possible 
loss?  Page  101. 

12.  How  is  appreciation  accounted  for  in  the  books? 

Page  102. 


ACCOUNTING  529 

Manufacturing  Accounts. 

1.  How  does  the  manufacturing  accounting  differ  from 
the  accounting  of  an  ordinary  retail  business? 

Pages  106, 122. 

2.  How  is  the  expense  side  of  manufacturing  shown  in 
the  books?  Page  107. 

3.  What  items  would  appear  on  the  debit  side  of  the  pro- 
duction account  of  the  manufacturing  department  of  a 
concern?  On  the  credit  side?  What  would  the  ac- 
count show?  Pages  110,  111. 

4.  What  does  the  trade  value  represent?   Pages  112, 124. 

5.  How  is  the  cash  which  is  received  by  the  selling  end 
of  a  concern  treated  in  the  books?  Page  114. 

6.  How  does  the  profit  shown  by  a  manufacturing  or 
packing  department  differ  from  the  profit  shown  by 
the  selling  department?  Page  114. 

7.  When  departmental  ledgers  are  kept,  what  accounts 
are  found  in  the  general  ledger?  Page  116. 

8.  What  is  the  purchases  analysis  book?  Page  119. 

9.  Give  a  method  by  which  the  amount  of  materials  is- 
sued may  be  kept  track  of.  Page  120. 

10.    Wliat  items  must  an  accounting  system  keep  sepa- 
rate? '  Page  121. 
Cost  Accounting. 

1.  Define  cost  accounting.  Page  123. 

2.  Why  is  it  impossible  to  know  the  exact  cost  of  units 
of  goods  by;  the  departmental  system  of  accounting? 

■■>  Page  123. 

3.  What  is  the  object  of  cost  accounting?         Page  124. 

4.  Describe  a  cost  sheet.  Page  125. 

5.  Of  what  use  is  the  cost  sheet?  Page  126. 

6.  Explain  the  use  of  the  individual  cost  sheet.  Page  127. 

7.  How  can  the  cost  accounting  be  carried  on  as  a  part 
of  the  general  accounting  system?  Page  128. 

8.  What  is  the  nature  of  the  contract  ledger?   Page  131. 

B— VIII— 34 


630  QUIZ  QUESTIONS 

9.    What  is  the  use  of  the  bought  ledger?  Page  133. 

10.  What  is  the  work  of  the  cost  ledger?  Page  135 

11.  Name  the  four  bases  of  cost  accounting.   What  method 
of  accounting  is  adopted  for  each  basis?       Page  140. 

12.  Of  what  does  the  problem  in  cost  accounting  as  ap- 
plied to  modem  business  consist?  Page  140. 

13.  What  is  the  best  cost  system  for  a  concern  of  large- 
scale  production?  Page  142. 

Profit  and  Loss  Accounts. 

1.  What  difficulties  arise  in  the  profit  and  loss  account- 
ing as  the  operations  of  a  business  increase  in  complex- 
ity? Page  145. 

2.  What  is  shown  by  each  of  the  four  sections  into  which 
profit  and  loss  account  may  be  divided? 

Pages  147,  148. 

3.  What  important  facts  are  shown  by  the  sub-divided 
profit  and  loss  account?  Page  150. 

4.  What  general  principle  is  followed  in  sub-dividing 
profit  and  loss  account?  Page  151. 

5.  Into  what  classes  may  all  incomes  and  expenditures 
be  divided?  Page  152. 

6.  How  should  increased  assets  be  treated  in  the  books 
of  a  firm?  Page  153. 

7.  How  can  the  profit  and  loss  account  be  made  to  show 
the  results  of  a  business  for  a  fiscal  period?  Page  156. 

8.  How  must  a  profit  and  loss  account  which  shows 
simply  the  increase  in  cash  be  supplemented? 

Page  159. 

9.  Give  an  instance  where  dividends  should  not  be  de- 
clared even  when  a  profit  has  been  earned.  Page  160. 

The  Balance  Sheet. 

1.  What  simple  rules  aid  in  determining  whether  an  item 
is  an  asset  or  a  liability?  Page  163. 

2.  Give  an  example  of  an  accrued  expense.      Page  163. 


ACCOUNTINa  531 

3.  What  is  a  balance  sheet*?  Page  166. 

4.  When  will  depreciation  appear  in  the  balance  sheet 
as  an  asset *?    As  both  an  asset  and  a  liability'? 

Page  168. 

5.  Describe  the  standard  form  of  balance  sheet. 

Page  169. 

6.  How  does  the  English  form  of  balance  sheet  differ 
from  the  American  form?  Page  170. 

7.  What  must  a  person  have  in  order  to  interpret  a  bal- 
ance sheet?  Page  173. 

8.  Wliat  knowledge  of  a  business  does  a  balance  sheet 
show?  Page  174. 

9.  What  is  the  object  of  the  double  account  system  of 
balance  sheet?  Page  176. 

10.  How  is  depreciation  treated  in  the  double  account 
system?  Page  177. 

11.  Why  is  the  double  account  system  of  no  use  in  the 
case  of  a  bank?  Page  179. 

12.  What  is  the  nature  of  a  statement  of  affairs? 

Page  182. 

13.  What  is  a  deficiency  account  ?  Page  183. 

Auditing  and  Reporting. 

1.    What  is  auditing?  Page  185. 

2     What  is  the  legal  aspect  of  auditing?  Page  185. 

3.  Hlustrate  the  commercial  side  of  auditing.    Page  186. 

4.  How  does  the  auditor  check  up  the  accounts  of  a  busi- 
ness? Page  187. 

5.  What  rules  may  be  adopted  by  a  concern  in  order 
to  guard  against  fraud  in  its  accounting?    Page  189. 

6.  What  are  the  responsibilities  of  an  auditor? 

Pages  191,  192. 

7.  How  does  an  auditor  proceed  to  examine  the  payments 
and  receipts  of  cash  and  the  cash  items  of  a  bank? 

Page  194. 


532  QUIZ  QUESTIONS 

8.    What  is  meant  by  the  analysis  of  an  account? 

Page  196. 
Accountancy  Examinations. 

1.  What  methods  characterize  the  present  tendency 
toward  regulation  of  the  accountancy  profession? 

Page  211. 

2.  In  what  way  are  the  professional  standard  and  meth- 
ods maintained?  Page  212. 

3.  Give  the  scope  of  examinations  required  to  authorize 
issuance  of  the  C.  P.  A.  certificate.  Page  214. 

4.  Name  the  suggestions  made  with  reference  to  ex- 
aminations. Page  215. 

5.  ^AHierein  do  examinations  for  auditing  differ  from  ex- 
aminations for  accountancy?  Page  216. 

6.  How  extensive  a  knowledge  of  law  should  a  student 
have?  Page  219. 

7.  What  knowledge  of  mathematics  is  desired  in  an  ac- 
countant's equipment?  Page  221. 

8.  In  what  way  is  a  general  preliminary  education  de- 
sirable? Page  224. 

Accounting  Terminology. 

1.  In  what  respects  do  accounts  kept  by  the  executive 
officers  of  the  Government  differ  from  those  kept  by 
the  general  fiscal  officers?  Page  245. 

2.  What  two  types  of  accounts  are  used  in  private  busi- 
ness? Pages  245,  246. 

3.  Distinguish  between  *' proprietorship  accounts,"  and 
** fiduciary  accounts."  Page  246. 

4.  What  books  are  usually  kept  by  municipalities? 

Page  247. 

5.  What  are  the  principal  innovations  introduced  by 
modem  accounting?  Page  248. 


ACCOUNTINa  533 

6.  How  may  properly  kept  aecoimts  be  an  aid  to  honest 
municipal  government?  Page  249. 

7.  Give  and  describe  the  two  general  types  of  accounts 
that  have  recently  been  introduced  by  many  city  gov- 
ernments. Page  250. 

8.  How  do  some  cities  make  use  of  accounting  in  their 
attempt  to  measure  the  efficiency  and  economy  of  their 
administration?  Page  251. 

9.  Discuss  difficulties  arising  when  payment  of  warrant 
is  deferred  for  long  periods,  referring  to  both  past  and 
present  issues.  Pages  251,  252. 

10.  What  are  the  two  important  results  to  be  accomplished 
in  city  governments  by  a  correct  accounting  system? 

Pages  253,  254. 

11.  Give  the  reason  for  non-uniformity  even  among  skilled 
accountants.  Pages  254,  255. 

12.  What  is  accounting  as  defined  by  Mr.  Powers? 

Page  255. 

13.  Distinguish  between  nominal  and  actual  assets. 

Page  257. 

14.  Define  funds;  investments.  Page  258. 

15.  What  is  the  diiference  between  bills  receivable  and 
accounts  receivable?  Page  260. 

16.  What  is  the  weakness  of  most  city  "asset  accounts"? 

Pages  261,  262. 

17.  How  has  the  infiuence  of  the  Bureau  of  the  Census 
tended  to  promote  accuracy  and  regularity  in  city 
** asset  accounts"?  Page  262. 

18.  Define  liabilities;  debts;  fixed  debts;  floating  debts. 

Pages  264,  265. 

19.  What  are  the  two  general  classes  of  trusts  ?  Page  266. 

20.  Classify  liabilities  under  three  heads.  Page  267. 

21.  What  is  the  objection  to  classifying  proprietary  in- 
terests with  general  liabilities?  Page  268. 

22.  How  does  the  Bureau  of  the  Census  distinguish  be- 


534  QUIZ  QUESTIONS 

tween  the  claims  of  creditors  and  proprietary  inter- 
ests? Pages  268,  269. 

23.  How  are  proprietary  interests  variously  designated? 

Page  269. 

24.  Distinguish  between  permanent  and  temporary  re- 
serves. Page  270. 

25.  What  is  the  difference  between  unreserved  and  re- 
served interests  of  beneficiaries'?  Page  272. 

26.  What  is  meant  by  nominal  revenue  accumulations? 

Pages  273,  274 

27.  Define  the  two  classes  of  governmental  reserves. 

Pages  274,  275. 

28.  Itemize  the  various  expenses  of  a  government  coming 
under  the  heads,  general  and  commercial  expenses. 

Pages  276,  277. 

29.  In  governmental  accounting,  what  is  included  in  the 
term  ''interest"?  Page  278. 

30.  From  what  sources  do  governments  derive  their  in- 
come? Page  280. 

31.  Define  the  following  forms  of  taxes:    Property  tax, 
business  taxes,  license  tax,  poll  tax.  Page  282. 

32.  How  does  the  Bureau  of  the  Census  classify  the  two 
forms  of  privileges?  Pages  283,  284. 

33.  Define  fees;  charges.  Page  284. 

34.  What  are  the  real  or  actual  receipts  of  a  governing 
body?  Page  286. 

35.  For  what  four  purposes  are  government  revenues  in- 
tended? ^  Page  287. 

36.  From  what  two  sources  do  municipalities,  states,  etc., 
draw  their  revenue?  Pages  287,  288. 

37.  What  are  ''counterbalancing  payments  and  receipts," 
and  into  what  four  classes  are  they  divided? 

Page  289. 

38.  What  are  nominal  payments  and  receipts?  Page  290. 

39.  Define  investment  transfer  payments  and  receipts; 
major  transfer  payments  and  receipts.  Page  291. 


ACCOUNTINa  535 

40.  How  did  the  expressions  "ordinary"  and  ** extraordi- 
nary" payments  and  receipts  originate? 

Pages  291,  292. 

41.  How  are  extraordinary  expenses  generally  met  by  tlie 
average  state*?  Page  293. 

42.  What  facts  should  a  proprietorship  account  disclose? 

Page  295. 

43.  What  are  ''controlling  accounts"?  Page  297. 

44.  What  special  conditions  should  government  summa- 
ries show?  Pages  298,  299. 

45.  Classify  the  important  facts  that  should  be  brought 
out  in  the  general  summary  of  expenditures. 

Pages  299,  300. 

46.  How  should  summaries  of  government  receipts  be  ar- 
ranged? Pages  302,  303. 

47.  In  order  to  be  of  the  greatest  administrative  assist- 
ance, how  should  payments  and  receipts  be  finally 
classified?  Pages  304-306. 

48.  What  question  arises  in  keeping  the  accounts  of  a 
city  whose  general  property  taxes  are  never  collected 
in  the  year  when  levied?  Page  309. 

49.  According  to  many  accountants  what  limitations  are 
to  be  placed  upon  proprietary  accounts  ?       Page  311. 

50.  In  addition  to  showing  facts  with  reference  to  re- 
sources provided  or  expended  in  carrying  out  the  ad- 
ministrative policy,  what  additional  facts  should  gov- 
ernment accounts  show?  Page  312. 

51.  What  confusion  arises  on  account  of  accountants'  in- 
discriminate use  of  the  terms  "balance  sheet"  and 
"profit  and  loss"?  Pages  313,  314. 

Changes  in  Government  Accounting. 

'1l,  How  far  are  the  methods  of  transacting  business  by] 
the  Government  adapted  to  their  purpose?  Page  315. 

2.  What  was  the  probleipa  in  the  reorganization  of  the 
Treasury  Department?  Page  318, 


536  QUIZ  QUESTIONS 

3.  Name  the  general  classes  under  tlie  head  of  general 
accountSo  Page  320. 

4.  Describe  the  recommendations  for  accounts  of  disburs- 
ing officers.  Page  321. 

5.  What  class  of  operations  of  the  Government  was  first 
put  under  cost  accounting?  Page  323. 

6.  Describe  the  situation  met  in  the  Government  Print- 
ing Office.  Page  326. 

7.  What  were  the  main  ideas  covered  by  Mr.  Leech  under 
his  plan  of  cost  accounting*?  Page  327. 

8.  Explain  the  system  in  its  operation.  Page  328. 

9.  Describe  the  method  in  ordering  work  done  by  the 
Government  Printing  Office.  Page  333. 

10.  Describe  the  system  of  cost  accounting  used  in  the 
mints,    ^^-^^^r:^.  Page  341. 

11.  What  is  the  general  plan  of  cost  accounting  used  in 
the  Census  Bureau?  Page  343. 

12.  Give  the  general  effect  of  the  changes  wrought  by 
cost  accounting  in  government  work.  Page  347. 

Corporation  Tax  Regulation. 

1.  What  is  the  general  subject  of  section  38  of  the  Act  of 
Congress,  August  5,  1909?  Page  348. 

2.  To  what  class  of  companies  does  the  act  apply? 

Page  353. 

3.  Analyze  the  definitions  and  rules  for  determining  in- 
come of  the  various  classes  of  corporations.  Page  353. 

Federal  Corporation  Tax. 

1.  What  special  difficulty  is  met  with  in  legislation  by 
accountants?  Page  367. 

2.  What  do  the  official  regulations  for  making  up  the 
tax  returns  show?  Page  371. 

3.  Show  the  difficulty  in  providing  for  depreciation  under 
the  act.  Page  377, 


ACCOUNTINa  537 

4,  Wliat  will  probably  be  the  rule  as  to  deductions  on 
account  of  cumulative  dividends  ?  Page  380. 

5.  Name  a  few  of  the  problems  which  will  require  ad- 
justment in  the  assessment  of  tax  on  net  incomes  of 
corporations.  Page  382. 

Primer  on  Cost  Keeping. 

1.  Give  the  general  suggestions  of  the  author  for  the 
analysis  of  costs.  Pages  387,  388. 

2.  What  is  the  governing  principle  of  cost  accounting'^ 

Page  391. 

3.  Name  the  two  classes  of  government  factories  and 
classify  their  operations.  Pages  394,  395. 

4.  What  are  the  two  general  classes  under  which  prac- 
tically all  the  expenditures  of  a  given  enterprise  fall? 

Page  399. 

5.  What  distinction  is  to  be  made  between  cost  and  pur- 
chase price?  Page  401. 

6.  Name  the  expenses  generally  included  in  the  factory 
burden.  Page  404. 

7.  Give  the  author's  suggestions  for  the  apportionment 
of  indirect  charges.  Page  405, 

8.  Describe  briefly  the  two  systems  for  combining  the 
records  of  the  elemental  costs.  Page  409. 

9.  What  two  costs  are  to  be  considered  in  government 
contract  work?    How  are  these  costs  computed? 

Pages  411, 412. 

Principles  of  Cost  Accounting. 

1.  Give  the  main  cause  why  cost  systems  have  been  fail- 
ures. Page  415. 

2.  Name  the  first  feature  in  an  understanding  of  manu- 
facturing cost;  the  second;  the  third.    Pages  415-418. 

3.  At  what  point  does  accounting  for  cost  cease  and 
selling  cost  begin?  Page  421. 


538  QUIZ  QUESTIONS 

4.  Analyze  the  various  elements  that  enter  into  manu- 
facturing cost.  Page  423. 

5.  Differentiate  between  the  various  systems  of  calcu- 
lating factory  expenses.  Page  425. 

6.  Name  the  factors  that  are  included  in  machine  costs. 

Page  428. 
Legal  Decisions. 

1.  On  what  basis  should  the  capital  stock  of  a  corpora- 
tion be  assessed  for  taxation?  Page  432. 

2.  How  should  real  estate  be  assessed  for  taxation? 

Page  433. 

3.  Give  the  basis  for  valuation  of  personal  property  and 
franchises.  Page  435. 

4.  In  ascertaining  the  valuation  for  taxation  of  prop- 
erty for  water  supplying  purposes,  what  elements 
should  be  considered?  Page  445. 

5.  In  fixing  the  dividend  returns  on  stock  of  a  public 
service  corporation  what  should  be  the  basis  of  valu- 
ation? Page  459. 

The  Balance  Sheet  of  a  Railway. 

1.  Outline  the  form  of  general  balance-sheet  statement 
required  by  the  Interstate  Commerce  Commission  in 
the  annual  report  of  carriers  to  this  Commission. 

Pages  465-469. 

2.  Name  the  different  forms  of  secured  debt  that  are 
generally  carried  on  the  books  of  a  railway  company. 

Page  468., 

3.  What  items  should  appear  on  the  accounts  of  prop- 
erty owned,  as  investment?  Pages  469-473. 

4.  Outline  briefly  the  deferred  debit  items,  and  tell  in 
detail  how  discount  on  stock  and  discount  on  funded 
debt  are  treated.  Pages  476-482. 

5.  How  should  the  amounts  entering  into  the  capital 
stock  account  be  subdivided.  Page  482, 


ACCOUNTING  539 

6.  Kame  and  describe  tlie  six  items  generally  compris- 
ing the  funded  debt.  Pages  484,  485. 

7.  What  are  the  various  forms  of  matured  interest  ob- 
ligations that  may  appear  on  books  of  a  railway  com- 
pany? -  Page  488. 

8.  Give  a  list  of  items  that  are  generally  found  on  the 
accounts  of  items  in  suspense.  Page  491. 

The  Accounts  of  a  Telephone  Company. 

1.  Name  the  objects  in  a  scheme  of  accounting. 

Page  494. 

2.  Analyze  the  limitations  on  these  objects.    Page  494. 

3.  Give  the  general  plan  in  constructing  the  scheme  of 
accounting.  Page  497. 

4.  What  four  main  groups  must  be  dealt  with  in  any 
scheme  of  accounts?  '  Page  498. 

5.  Name  the  principal  property  of  an  operating  tele- 
phone company.  Page  499. 

6.  Give  the  four  general  classes  into  which  the  plant  is 
divided  for  accounting  purposes.  Page  501. 

7.  Into  what  classes  would  equipment  accounts  be  di- 
vided? ,  Page  501. 

8.  How  may  outside  plant  be  divided?  Page  503. 

9.  Give  the  reasons  for  distinguishing  between  exchange 
and  toll  lines.  Page  503. 

10.  Summarize  the  reasons  for  classifying  the  plant  ac- 
counts. Page  504. 

11.  What  is  meant  by  plant  unit  costs?  Page  505. 

12.  What  classes  of  property  come  under  the  head  of 
working  assets?  Page  506. 

13.  What  classes  are  comprised  under  current  assets? 

Page  508. 

14.  Name  the  three  general  classes  of  liabilities. 

Page  510. 

15.  Describe  the  several  forms  of  capital  obligations. 

Page  510. 


640  QUIZ  QUESTIONS 

16.  What  obligations  would  be  included  in  current  lia- 
bilities? Page  511. 

17.  Analyze  reserves  and  surplus  accounts.       Page  512. 

18.  Give  the  methods  of  accounting  for  revenue. 

Page  516. 

19.  Describe  the  type  of  department  organization  for  ac- 
counting purposes.  Page  519. 


INDEX 


ACCOUNTING. 


APPRECIATION-^ 

theory  of,  102, 
ASSETS— 

accounts  of,  261. 

capital,  169. 

classified,  287. 

defined,  162,  256. 

how  related  to  balance  sheet,  162. 

how  "written  down,"88. 

rules  for  determining,  163. 
AUDIT— 

analytical,  196. 

defined,   185. 

example  of,  193. 

function  of,  186. 

process  of  making,  187. 
AUDITING— 

examinations  in,  '216. 
AUDITOR— 

form  of  report  of,  197. 

national   bank   examiner's   report. 
198. 

report  of,  192. 

responsibility  of,  191. 

BALANCE  SHEET— 

accrued  items  on,  164. 

capital  and  revenue  items  in,  175. 

classification  of  items,  169. 

depreciation,  how   represented   in 
168. 

double  account  form  of,  177. 

explained,  40. 

form  of,  167,  179. 

interpretation  of,  193. 

object  of,  161. 

of  railroads,  169. 

of  Interstate  Commerce  Commis- 
sion, 465. 

relation   to   assets   and   liabilities, 
162. 

relation    to    statement   of   affairs, 
181. 

standard  form  of,  169. 

under    English     companies    acts, 
179. 
BALANCING— 

explained,  35. 

BANK  ACCOUNT— 
explained,  56. 


BANKS— 

corporation  tax  on,  353. 
BENEFICIARIES— 

interests  of,  271. 
BETTERMENTS— 

relation  to  profit  and  loss,  153. 
BILL  BOOKS  — , 

described,  ^3. 
BILLS  PAYABLE— 

how   accounted   for,   66. 
BILLS  RECEIVABLE— 

account,  60. 
BOOKKEEPING— 

defined,  4. 

method  of  relating  books  to  one 
another,  54. 

place  of  inventory  in,  38. 

principles  of,  24  ff. 

under  corporation  tax,  361. 
BOOKS— 

original  titles  of,  25. 

other  forms  of,  32. 
BONDS— 

accounting  for,  53. 
BOUGHT  AND  SOLD  ITEMS— 

classified,  10. 

CAPITAL— 

discussion  of,  43  ff. 

how   contributed,  44. 
CAPITAL  ACCOUNT— 

form  of,  18. 

of  corporation,  46. 

problems  of,  43. 

titles  of,  44. 

where  grouped,  IT. 
CAPITALIZATION-, 

explained,  45  fi. 
CASH  ACCOUNT— 

form  of,  19. 

relation  to  other  accounts,  67. 

substitutes  for,  55. 

theory  of,  54. 
CENSUS— 

cost  analysis  in,  343. 
CERTIFICATE— 

of  stock  book,  explained,  49. 
CERTIFIED  ACCOUNTANTS— 

in  various  states,  7. 


541 


542 


INDEX 


CHASE— 

on  auditing,  217. 
CHECK— 

how    classed   and   accounted   for, 
56. 
CITY    OF    KNOXVILLE   WATER 
CO.— 

quoted,  437. 
CLOSING— 

explained,  35. 

process  of,  37. 
COLE— 

quoted,  94n. 
COAIAIERCE— 

nature  of,  2. 
COMMERCIAL  LAW— 

examination  in,  218. 
COMMERCIAL  PAPER— 

use  of,  59. 
CONSIGNMENT   ACCOUNT— 

explained,  73. 

form   of,   75. 
CONSIGNMENTS— 

discussed.  73. 
CONTINGENT  LIABILITY— 

nature  of.  68. 
CONTINUOUS  PROCESS  INDUS- 
TRIES— 

difficulty    of    cost    accounting    in, 
1S8. 
CONTRACT    LEDGER— (See    Led- 
ger,  Contract.) 
CORPORATION— 

capital  account  of,  46  fif. 
CORPORATION  TAX— 

discussion  of,  367  ff. 

regulations      for      administration, 
348. 
COST  ACCOUNTING— 

basis  of,  139. 

choice  of  system  for,  141. 

controversy  as  to,  144. 

dangers    of  use,   142. 

discussed,    122. 

principles  of,  discussed,  415. 

reason  for,  124. 

relation  to  general  books,  128. 
COST  BOOKS— 

described,  130. 
COST  KEEPING— 

primer  on,  387. 
COST  LEDGER— 

explained,  133. 
COSTS— 

at  mints,  341. 

how  analyzed,  136. 

of  statistics,  343. 
COST  SHEET— 

explained,  125. 
COST  SLIP— 

explained,  127. 
CREDITOR  AND  DEBTOR— 

(See    Debtor   and    Creditor.) 


C.  P.  A.  CERTIFICATE— 
explained,  222. 

DAY  BOOK— 

explained,  26. 

sample  of,  29. 
DEBTOR  AND  CREDITOR— 

explained,  117. 
DEBTS— 

current,   264. 

floating,  265. 

funded.   264. 
DEDUCTIONS— 

from    income    under    corporation 
tax    357 
DEFICIENCY  ACCOUNT— 

explained,  182. 

form  of,   184. 
DEPARTMENTAL     ACCOUNTS— 

explained,  105  fT. 
DEPRECIATION— 

causes  of,  96. 

dangers  of,  100. 

in  balance  sheet,  168. 

modes  of  accounting  for,  94. 

relation  to  "writing  down,"  89,  90, 

reserve  for,  92. 

theory  of,  87. 

ways  of  estimating,  97. 
DEPRECIATION  ACCOUNT- 

form  of,  91. 
DICKINSON— 

quoted  on  balance  sheet,  169. 
DISBURSING  OFFICERS— 

vouchers  and  balances,  320. 
DISCOUNT— 

at  bank,  61. 

on  stock,  53'. 
DISHONORED  BILLS— 

how  accounted  for,  64. 
DIVIDENDS— 

relation  to  profit  and  loss,  160. 
DOUBLE  ACCOUNT  SYSTEM— 

described,  177. 

form  of  balance  sheet,  178. 
DOUBLE  ENTRY— 

reason  for,  24. 

ECONOMICS— 

relation  of,  to  accounting.  3. 
ENGLISH   COMPANIES  ACT— 

requirements  of,  on  balance  sheet, 
179. 
EXAMINATION— 

in  accounting.  8. 

mode  of  conducting,  231. 

questions   in   accountancy,  225   ff. 
EXPENSES— 

commercial,  277. 

general,  276. 

FEES— 

explained,  284. 


INDEX 


543 


FRAUD— 

protection  against,  189. 
FUNDED  DEBT— 

explained,  264. 

GAIN— (See   Loss.) 
GOODS  ACCOUNT— 

analysis    of,    69. 

form  of,  19. 

invoices  of,  70. 

nature    of,   68. 

return  of,  70. 

subdivisions    of,    in      relation    to 
trading  account.  80. 
GOOD-WILL— 

how  accounted  for,  53. 
GOVERNMENTAL  ACCOUNTS— 

cost  accounting  of,  323. 

described,  247. 

new  systems  of,  250. 

recent  changes  in  federal,  315. 

uniformity  in,  252. 

IMPOSTS— 

how    dealt    with    in   principal    ac- 
counts, 355. 
INCOME— 

application  of  corporation  tax,  353. 
INCOME  ACCOUNT— 

explained,   151. 
INCOME  SHEET— 

of  railroads,  155. 
INSURANCE— 

analogy    to    depreciation    reserve, 
101. 
INSURANCE  COMPANIES— 

corporation  tax  on,  354. 
INTERSTATE  COMMERCE  COM- 
MISSION— 

form   of  balance   sheet,   179. 
INVENTORIES— 

under  corporation  tax,  359. 
INVENTORY— 

place   in   bookkeeping.   38. 
INVENTORY  CLOSING— 

explained,  82. 
INVESTMENTS— 

explained,  278. 
INVOICES— 

relation  to  goods  account,  70. 
INVOICE  BOOK— 

described,  35'. 
ITEMS— 

accrued, 

accounting  for,  163. 
bought  and  sold,  10. 

JOURNAL— 

explained,  27. 

sample  of,  29. 

writing  up,  28. 
JOURNALIZING— 

defined,  35. 


LEDGER— 

classes  of,  31. 
contract,  explained,  135. 
cost,  133-137. 

explained,   133. 
illustrated,   137. 
posting  and  closing,  134. 
explained,  26. 
general, 

contents   of,   116. 

relation  of,  to  cost  accounting, 

129. 
stock,  explained,  48, 
LEGISLATION— 

on  accounting,  211. 
LIABILITIES— (See  Assets.) 
LISLE— 

on  statement  of  affairs,  182. 
quoted,  149. 

quoted  on  balance  sheet,  166. 
LOSS  AND  GAIN— 

classified,  10. 
LOSSES— 

under  corporation  tax,  358, 

MANUFACTURING  ACCOUNTS— 

difficulty  of  cost  system  in,  1S8. 

forms   of,  115. 

peculiarity  of,  106. 

problem  of,  103. 
MANUFACTURING  COMPANIES. 

corporation   tax  on,  354. 
MATERIAL  RECORD— 

illustrated,    138. 
MATHEMATICS— 

knowledge  of,  in  accounting,  220. 
MERCANTILE  COMPANIES— 

corporation  tax  on,  354. 
MINTS— 

cost  analysis  at.  341. 
MUNICIPAL  BUSINESS— 

correct  methods  needed,  253. 

NATIONAL  BANKS— 

examiner's  report  on,  198. 
statement  of  condition  of,  172. 

OPENING  ENTRIES— 

explained.  34. 
ORGANIZATION— 

of  accounts,  discussed,  105. 
OVERHEAD  CHARGES— 

in  profit  and  loss,  148. 

PEOPLE  EX   REL.   M.   RY.   CO. 

V.  BARKER— 

quoted,  430. 
PAY-ROLLS— 

treatment  of,  119. 
PENALTIES— 

under  corporation  tax.  365. 
PHILOSOPHY   OF  ACCOUNTS— 

place  of,  1. 


544 


INDEX 


PLANT  ACCOUNT— 

described,  85, 
explained,  83. 

relation  to  depreciation,  87. 
POSTING— 

explained,  27,  36. 
PREMIUM— 

on  stock,  53. 
PRINTING  OFFICE— 
government,  324-341.  _ 

cost  accounting  in,  324. 
cost  system  of,  328-341. 
deficit  in,  325. 
PRIVILEGES— 

explained,  283. 
PRODUCTION  ACCOUNT— 

explained.  111. 
PROFIT  AND  LOSS— 

account,  where  grouped,  17. 
development  of,  20  ff. 
how  affected  by  discount,  63. 
relation  to  "closing."  39. 
technical  aspect  of,  in  manufactur- 
ing, 109. 
PROFIT  AND  LOSS  ACCOUNT— 
analysis   of,  158. 
classification  of,  147,  148. 
criticism  on  simple  form  of,  146. 
ideal  function  of,  156. 
illustrated,  149. 
original  form  of,  145. 
relation   to   revaluation,  157. 
theory  of,  144. 
use  of,  150. 
PROPERTY  ACCOUNT— (See  Plant 

Account.) 
PROPRIETORS— 

accounts  of,  245. 
PURCHASES  ANALYSIS  BOOK— 

illustrated,  119. 
PURCHASES  BOOK— 
explained,  30. 

RECEIPTS— 

explained,  284. 

ordinary  and  extraordinary,  291. 
RECKITT— 

on  principles  of  cost  accounting, 
415. 
RENT  ACCOUNT— 

form  of,  20. 
RESERVE— 

for  depreciation,  93. 

governmental,  274. 
REVENUE— 

analyzed,  278. 

on  balance  sheet,  175. 

SAKOLSKI— 

on  corporation  tax,  367. 
SALES   BOOK— 

explained,  30. 


SELLING— 

accounts  of,  in  manufacturing,  113. 
SINGLE     ACCOUNT      SYSTEM— 
(See   Double  Account  System.) 
STATEMENT   OF  AFFAIRS— 

explained,   181. 

form  of,   182. 
STATISTICS— 

cost  of,  343. 

how  obtained,  251. 

of  costs,  14S'. 

relation  to  accounting,  144. 
STOCK— 

certificate  of,  49. 

in  treasury,  49. 

issued  at  premium  or  discount.  S3. 

issues   of,  48. 

ledger,  48. 

payment  for,  50. 
STOCK  LEDGER— 

explained,  48. 
STORES  ISSUED  BOOK— 

explained,   120. 
SUMMARIES— 

accounting,  295  ff. 
SURPLUS  ACCOUNT—. 

service  of,  93. 

TAXES— 

analyzed,  281. 
TELEPHONE  COMPANY— 

accounts  of,  explained,  494. 
TERMINOLOGY— 

improvement   needed   in   account- 
ing, 254. 
TRADING  ACCOUNT— 

explained.   78. 
TRANSFERRING— 

explained,  37. 
TRANSPORTATION 

COMPANIES^ 

corporation  tax  on,  354. 
TREASURY— 

accounting  of,  317. 
TRIAL  BALANCE— 

explained,  36. 

significance  of,  165. 
TRUSTEES— 

accounts   of,  245. 
TRUSTS— 

explained,  265. 

UNIFORMITY— 

in  accounts,  252. 
UNIT  COST— 

problem  of,  138. 

VOUCHERS— 

of  disbursing  officers,  320. 

WAGES—  .      , 

use  of  pay-rolls  in  accounting  tor, 
11$. 


INDEX 


WILCOX    ET   AL.    V.    CONSOLI- 
DATED  GAS  CO.— 
quoted,  448. 


WRITING  DOWN"- 
criticism  of,  90. 
explained,  86. 


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